Sideways financial markets gotcha down?

You might have noticed that the financial markets saw liftoff in the last several months as they powered up to levels not seen since May 2010.  At that time there was that mysterious and massive sell off of equity markets caused by that dufus trader entering too many zeroes.  While the causes of that event were still being explored the Greek debt crisis unfolded.  Then we spent nearly six months spinning our wheels.  But then there was a climb back to those levels.

Many investment commentators, especially academics, argue that the financial markets accurately price assets based on the news that is available.  If we take that as an accurate model (which I don’t) then the fact that financial markets are about where they were in May ought to mean that the level of risks and opportunities in the financial markets is the same as it was then.  This simply is not true.  So what has changed?

Subsequent to May there have been many encouraging economic signs that just weren’t happening then.  Among the most important things is that consumers are continuing to spend despite their unemployment situation worries.  Another very important thing is that business profitability is strong.  Further, that profitability is starting to come not just from expense cutting, but also from actual revenue growth.  Additionally, despite the fact that Ireland is having budgetary problems, Europe is a much more stable Union than it was before the Greek debt crisis.  This is because they have dealt with some of the structural gaps that existed in their charter.  This means that Europe has mechanisms in place that can deal with European problems.

I could go on enumerating positives, but my point is that the economy is stronger now than it was then.  So why are markets going sideways and not up?  I think that there is a general nervousness about:

1. The mood of the U.S. consumer.  Consumer spending remains much lower than its pre-recession levels.  My intuition is that it will be many years before it returns to pre-recession levels.  This is a somewhat legitimate concern.  Because what is really happening is that consumers are finally learning to live within their means.  Long-term this is a very, very important thing.
2. The lack of hiring by U.S. businesses.  This will change, but again, only very slowly.  Until new ideas need new employees to execute them, businesses will not hire.  Or until businesses have much higher sales that require more people to fulfill them, businesses will not hire.  So unemployment is going to only very slowly improve.  This is a legitimate concern and frankly, it is my largest structural concern for the U.S. economy.
3. What is going to happen in Europe?  Investors have now turned their attention away from Greece and are focusing on Ireland, another country that gorged itself on cheap debt and that has budgetary problems.  This is an illegitimate worry.  Ireland is substantially stronger than Greece and for lots of reasons.  Their debts as compared to economic output are not nearly as high as are the Greek’s debts.  Ireland also has a real economy that produces real goods that create real jobs that creates a real tax base that leads to a stronger fiscal situation.  Greece has tourism and subsidies.  Etc.
4. What will happen in Washington?  Will the new Republican force of will lead to lower taxes, which will lead to more income, which will lead to greater prosperity?  Honestly, who cares?  As an investor you can never accurately predict what Washington politicians are going to do in advance.  Instead, you have to adjust only after legislation is enacted.  In other words, paradoxically you have to ignore their gyrations until you cannot.  So any concern here is illegitimate in my mind.
5. The Holiday shopping season.  Investors may be nervous about retail sales this Holiday season.  This is a subset of #1 above.  For too long the U.S. economy has relied upon a gluttonous U.S. consumer.  My expectation is that retail sales will slightly surprise.  The basis for my belief is simply a feeling.  It just seems to me that people aren’t as grumpy now as they were a year ago.  Any concern here is semi-legit.

In summary, in my mind we are mostly left with very few legitimate concerns.  What do we have then?  I think we simply have investor skittishness and malaise left over from the worst equity market performance in 80 years.  And this too shall pass.

Jason