I’ve started to think that one of the reasons that the stock market has underperformed such other asset classes as bonds and precious metals over the past decade relates to little more than overoptimism. There is evidence that this may still be continuing, despite the Great Recession and the current spate of gloomy headlines on such mainstream sources as RealClearMarkets, which leads today in its headline summary with about ten consecutive reasons why the financial/economic world as we know it is at risk of ending. It’s not exactly ending, but dealing with such errors of overoptimism such as housing bubbles is not easy and warrants downbeat headlines.
Stateside, one way to gauge levels of optimism in the business community comes from regional Fed manufacturing surveys, such as those of (always cyclical) manufacturers. These enquire of selected manufacturers both how they are doing at the current time, and how they expect to be doing six months in the future. Of the various Fed surveys, the Philadelphia Fed has, it appears, the longest such series available on its web page.
Please click on the LINK to the latest Philadelphia Fed manufacturing survey. Please focus on the graph at the top right of the first page.
Survey participants have been much more optimistic about the future six months hence than actually came to pass for the past eleven or so years. Note how optimistic these survey respondents were almost throughout the entirety of the ‘Great Recession’. There was also extreme optimism coming out of the mild 2001 recession; but the future was much less wonderful. Perhaps that helps explain why 2002 was a miserable year in the stock market. Then note that the booming stock market of the second half of the ’90s was associated with realistic appraisals of the future. Perhaps that’s why the trend of stocks was up.
Other Fed surveys measuring expectations vs. current conditions show a similar pattern, as do certain private surveys such as ISM reports.
This decade-plus long failure of survey participants to “get real” may help explain the continued expectations of the “quants” such as GMO head Jeremy Grantham (e-mailed monthly data) and economist/consultant Andrew Smithers (LINK) whose “central tendency” is for very poor multi-year returns for U.S. stocks for some years to come, on average similar to bonds. Most of us root for higher stock prices, but ultimately the stock market proves to be a weighing and not a voting machine, interim bouts of enthusiasm and gloom, apathy and intense interest, notwithstanding.
Trading opportunities aside, ongoing data such as that which is presented here leads me to continue to invest cautiously. The aging U.S. investor base is getting more conservative in its preferences. Until businesspeople get better at aligning their perceptions of the future with what actually eventuates than they have been for years, I think that stocks that reflect this apparently chronic overoptimism will also generally remain challenged to perform well. Businesses that are well-run and are positioned realistically, with strong financial underpinnings, are in contrast likely to make their shareholders happy as time goes by.