Regular readers of this blog will recall the prediction a couple of weeks ago: short sellers on Wall Street and their accomplices in the financial media, especially cable TV, would use a confluence of threatening (but not yet realized) situations to whip up a frenzy of fear to trigger the market "correction" they had long waited for. And bet big on.
The October convergence included: the emergence of ISIS (including the likely fall of a well-positioned Syrian town on the Turkish border); new fears of a potential European recession due to an August slowdown in factory activity (who would have ever expected a slowdown in Europe in August??); an imported fatal case of Ebola in the US that was mishandled by the hospital and wound up infecting two nurses and led to mindless calls for "flight bans" from the affected African nations to the US (although those flights don't exist) to prevent a US epidemic; and even the murder of two soldiers by two Canadian jihadi converts. All these were cited day-in-and-day-out as urgent reasons to, as one trader put it "sell first and ask questions later." Bad advice, if you took it, as many did in 2010, 2011, 2012 and 2013 when the same type of traders confidently projected a string of stock-mageddon events: a Greek default leading to a Euro currency collapse; a US debt default; a German exit from the Euro; run-away US inflation as the Federal Reserve provided extraordinary market liquidity to fight asset deflation (including stocks); and even predictions that the Fed would "Septaper" its stimulus too early (2013) or too late (September 2014).
None of these eventualities actually happened, of course. But traders made a fortune when minor market corrections ranging up to 13% occurred just before the reality of strong corporate earnings or economic performance emerged. Not that the risks inherent in the situations noted above were not real. But they were intentionally blown out of proportion to shake stocks out of "weak hands" by traders who new darn well that the likelihood of stock-mageddon was remote and the evidence of continued growth was actually strong.
Theologians (unlike traders with a position to optimize) will tell you if asked that all sin starts with exaggeration. And the sin here was clearly exaggeration. Predictions of a new global recession began to appear in the financial media in early October just before the market took its dive, recycling much the same forecast that CNBC trotted out the previous October! This despite the fact of surging 4.6% US GDP growth in the second quarter of this year announced at the end of September, and employment growth announced in the first week of October reflected the best annual rate of job creation since the glory days of 1999!
How does this record of strong economic performance get replaced by a chorus of doom and gloom in just a week? Ask the cable news cycle and its vulnerability to the urge to "bring on the car crash" so we can cover it, providing a megaphone to the traders positioned to profit from a quick downturn on exaggerated fear, followed by a quick jump back up when the fears turn out to be far more manufactured than manifest. Call it the Bungee Market. Let's look at some examples.
UNITED RENTALS (ticker symbol URI): a well-regarded proxy for global economic activity. Its shares dropped in October from over 100 to the mid-80's as the fear trade took over in the second week of the month, but quickly and decisively rallied back to 107 at this writing (10/23/14) on the back of strong earnings and projections.
ILLINOS TOOL WORKS (ITW): a symbol of "nuts and bolts" industrial America, it dropped from an early-October high of 83 down to 79, but then blew through its previous high all the way to 87 after reporting stellar financial results.
HONEYWELL (HON): we feared results of this global, diversified industrial and technology company would reflect a bad European slowdown, but HON met earnings estimates and raised its forward guidance and its stock. Having fallen from 91 to 85 in early October, it jumped even higher to reach 94 after its report.
AMERICAN AIRLINES (AAL): the "index patient" of the transportation sector that was taken down from 36 to 28 on fears of Ebola contagion and travel bans, jumped back quickly to 38 once its strong earnings report came out.
PACKAGING CORPORATION OF AMERICA (PKG); a proxy for all manner of commercial activity, saw its stock beaten down from 63 to 58 amid downbeat economic chatter in the second week of October. But like others, PKG blew right through to an even higher price of 69 after strong earnings. "Sell first and ask questions later" would have cost you 10% with this stock in half a month and buying at the bottom would have produced a 19% return in just a few days. Annualize that!
SKYWORKS (SWKS): a semiconductor company that is a mainstay of the mobile revolution was blown down from 55 to 45 prior to earnings on a report of a purported market turn in the chip sector, but sprang right back to 55 when that rumor was debunked by its own earnings.
CELGENE (CELG): a leading biotech innovator, this stock slumped with the fear trade from 92 to 85, but jumped all the way to 100 on its monster quarterly financial report.
HARLEY-DAVIDSON (HOG): this well-known name slumped 60 to 55 on fears of consumer fright, but ran all the way through to 63 on great earnings.
HALLIBURTON (HAL): this well-known name in oil exploration tied to the fracking industry with the rumored "death of fracking," based on the sharp fall in oil prices due to global recession fears as well as abundant supply, slumped from 62 to 50, but is now back up 10% from its bottom after surprisingly strong quarterly earnings report.
Seen enough? Of course there were companies like IBM that went down and kept on going down after its horrible earnings report. That's as it should be, case by case, fact by fact. But since many market participants seem to have experienced a collective brain freeze about how they got fooled by the Armageddon trades of 2010 through 2013, maybe a few examples of how they got skinned again in October 2014 will serve as a memory aid for the rest of the year.
By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.