Why is the market rallying?

With so much bad news out there, why is the market rallying?

Here is my theory -- don't be shocked, it's nothing new really, just putting some data in context.

My theory is that expectations were low, very low. Lower than reality.

I follow earnings announcements for all reported companies on EarningsWhispers. And I happened to notice that the overwhelming majority of earnings news in the last two months have surprised on the upside (I have not computed a formal metric on this since it would actually involve counting and I'm not in a counting mood right now). My estimate is that at least 80% of companies came out with earnings "above estimate", about another 10-15% were "below estimates" and the rest "inline".

Another way of saying this is that the bad news has been baked into prices for a while -- the stock market being the forward-looking machine it is. And reality wasn't so bad after all. Many market participants are seeing the light at the end of the tunnel.

That doesn't mean we won't have an incoming train at the other end of the tunnel run us over. But it does explain why the market is rallying recently.

Sadly, none of this matters. No one knows what will come next. My best guess is that the two most likely outcomes are:
  1. This rally will stop very soon and we'll move sideways for a number of years, until inflation catches up with us and eats away the current returns, without many noticing (that's what the government wants to happen so that they get out of their enormous debt by devaluing it).
  2. The market is now adjusting to the current increased expectations just to be disappointed soon, given that the economy is nowhere near improving. Then the stock market will crash again.
Neither one of these outcomes is good for the short-term.

My reaction? I bought some TIPS last week. It's the only true "safe" investment if you earn in dollars and pay your bills in dollars.

But I won't stop there. I'm still planning on what to do next and it might just be "nothing", which is my favorite move most of the time.


  1. TIPS are only as good as the underlying CPI. Further scrutiny shows that the CPI is more often rigged than not. Moreover, the CPI usually lags its own distorted metric of inflation. Consequently, TIPS are not considered a serious protection against real inflation.

    Note that inflation is already happening -- look at the price of commodities since last fall. The monetary supply has doubled in just one year. This gigantic pool of money will inevitably come home to roost as more money will be chasing the fewer goods we make leading to rising prices.

    Serious investors protect against inflation by trading futures in commodity-related assets or buying commodity-related indexes. No wonder gold has stayed surprisingly strong when compared to any other asset class. Precisely for that reason, other commodities look substantially more attractive than gold right now like silver, sugar, cotton, and others. BTW, Silver is a great buy on any pullback (personally I will be buying frantically if it dips to $12).

  2. Check out Marc Faber's recent June 1, 2009 market commentary. (He could actually use a spell checker and a professional doc/pdf writing software...)