Efficient, Not Complacent

Are investors sleepwalking their way to disaster? Some say so, with global stocks once again flirting with all-time highs in the face of what many believe are big, bad negatives. The Greek debacle. Looming Fed rate hikes. China slowdown. They suggest investors are being too complacent, ignoring big risks-cause for alarm. But are markets really ignoring these things? Or are they instead doing what markets regularly do-efficiently discounting widely known information and moving on what is most likely over the mid-to-longer term.

Stocks, like all highly liquid markets, are forward-looking and efficient. Today's big news is near-always already reflected in stock prices, regardless of when "today" is or what the "big news" entails. Stocks usually aren't concerned with the right now. They're concerned with the foreseeable future. While sentiment can swing stocks in the short term, in our experience, stocks don't move on fundamental events that occur within the next three months or beyond the next 30 or so. Instead, they weigh-and move on-what is likeliest to occur between the next 3 and the next 30 months, focusing most on the next 12-18 months. While investors and headlines obsess over the day's headlines, markets look beyond the myopia and, usually, move on the things few talk about.

The existence of negatives-real or perceived-is typical in bull markets. The world is never pristine and needn't be for stocks to rise. Consider the present bull market: It wasn't born when some sounded the All Clear to Buy Stocks Again siren. It was born in early 2009, when the world economy was in rough shape but less bad than most headlines and investors feared. Folks feared Great Depression Part Deux, which became priced into markets, and, when it didn't come, stocks surged on positive surprise. Most often, markets weigh positives versus negatives, then compare the balance to sentiment-this is what good old Ben Graham meant when saying markets are weighing machines in the long run. If the positives outweigh the negatives over the foreseeable future, that is often good enough for stocks.

Stocks are overwhelmingly adept at overcoming perceived negatives. Even big problems in one corner of the world-Greece or otherwise-often aren't enough to tip the globe into recession or flip a bull to a bear. Not when fundamentals are otherwise positive. Latin America had a deep, long debt crisis in 1982/1983, which many feared would break the global financial system. But it didn't. The cyclical upturn in the US, UK and rest of the developed world offset it, and the bull market that began in August 1982 ran for five years. Europe's exchange rate mechanism collapsed during 1992 and 1993, and the fallout from defending, then discarding the currency peg wreaked havoc on European markets and stocks. But the powerful pull of America's expansion and bull market helped pull them-and the world-along. Global stocks rose 22.5% in 1993 and the bull continued through 2000-overcoming currency crises in Mexico, Korea, Thailand, Malaysia, Russia and Brazil along the way. Sometimes global markets corrected, as in 1998, and sometimes they didn't-sentiment is never predictable, nor does it have a uniform, consistent impact. But fundamentals always win in the long run, and the 1990s' fundamentals far outweighed occasional localized troubles.

Same goes for Fed rate hikes-almost always feared as they approach. Folks fretted rising rates would spell doom for the economic expansion in 1994. Even European investors feared Fed rate hikes would derail a budding bull market there. Sound familiar? The Fed hiked, but the bull marched on. 10 years later, investors again worried looming rate hikes spelled trouble for stocks. Yet 17 straight rate hikes from 2004-2006 didn't kill the bull.

Markets moving higher while bad news dominates isn't complacency-it is often market efficiency. True complacency is the opposite: when everyone emphasizes the positive and ignores or tries to whisk away the negative, usually with no logic and implausible reasoning. Late 1999/early 2000 is a perfect example. By early 2000, the Fed had inverted the yield curve and The Conference Board's Leading Economic Index was falling. A wave of low-quality firms went public, massively increasing stock supply. Most of these firms burned quickly through cash on hand, with little or no revenue coming in. But investors didn't notice and couldn't fathom the possibility of recession. Not in the "new economy!" Stocks started to fall in 2000 but investors "bought the dips," believing stocks would soon soar higher. They didn't, instead tumbling through early October 2002.

True complacency also preceded 1973-4's bear. In the early 1970s, the Nifty Fifty-50 high fliers from the late 1960s bull identified by then Morgan Guaranty Trust (now JPMorgan Chase)-were dubbed "one decision stocks." That one decision was buy, no matter what the economic or market outlook resembled.

We have the opposite today. Headlines and investors fret a smorgasbord of supposed risks that aren't even all that real! Greece is economically the size of Detroit. Initial Fed hikes have no history of derailing markets. China's slowdown is a deliberate product of government engineering, not an uncontrollable crash. Whatever might happen with mainland stocks, A-shares are insulated from global markets-what happens in China stays in China. Markets know all this and see these issues likely aren't so very bad.

Stocks can also see that over the next 3-30 months, things look pretty good. The global expansion appears set to continue, boosting corporate earnings and revenues. With gridlock persisting in most competitive developed nations, there is little risk of sweeping policy changes to discourage investment and risk-taking. LEIs are high and rising in much of the world-historically, an uncanny indicator of future growth. Broad money supply is accelerating-banks are lending, giving firms access to funds they need to invest and grow. Yield curves are steepening globally-a big positive supporting future investment and loan growth. Yet skeptical investors completely overlook that positive, instead fretting the rise in long-term rates. This, too, is the very opposite of complacency.

Overall and on average, the time to worry isn't when you see warnings of complacency scattered across financial media. Be wary when no one talks about complacency. That will be one sign we're near the top of the wall of worry and this bull market.