Investing in The Bizarro World

We’re now entering the phase of the investing cycle I like to refer to as, “The Bizarro World.” Of course, I’m making a pop culture reference to the fictional planet appearing in comic books published by DC Comics. In the Bizarro World, everything and everyone is essentially the exact opposite of what you’ll find here on earth.

What’s up is down, down is up, right is left, left is right – you get the picture. What I’m referring to with respect to investing, is the swinging of the pendulum from positive to negative sentiment, or vice versa. It’s a market phenomenon that can pop up without warning, or any definitive catalyst. Clearly we’re in the negative sentiment swing of the pendulum at the moment.

The stock market (S&P 500) is down 10% from its most recent high on September 20th of this year. All of a sudden, what was positive for the market six months ago is now somehow negative for the market. Hence, my reference to the Bizarro World. Nobody even remembers this now, but on January 26th of this year the stock market actually began a decline of more than 10% from its high, bottoming in early February before recovering.

None of this is new, of course. As long as there have been stock markets, there have been corrections and pendulum swings back and forth. That will never change. What I always find interesting though, is how the same news can be interpreted either positively or negatively, depending on where we are in the swing of the pendulum.

Let’s look at some examples.

Mr. Positive lives here on earth and here’s how he responds to various economic/market news:

• Company earnings are strong: This should support the rising stock market and prices going forward.
• Unemployment is low and going lower: This is a sign of a strong economy that’s just hitting its stride.
• Inflation is just beginning to creep in after a long recovery: This signals a strong economy and is good news for companies looking to increase prices and margins.
• The Fed is beginning to increase short-term interest rates: This is further proof the economy is healthy and strengthening and thus, stock prices will be supported by further growth.

Mr. Negative lives on Bizarro World and here’s how he responds to various economic/market news:

• Company earnings are strong: This is unsustainable and cannot continue much longer. Stock prices won’t be supported if earnings decline.
• Unemployment is low and going lower: This is a sign of an economy that is getting long in the tooth. We will soon be at capacity and a decline is inevitable.
• Inflation is just beginning to creep in after a long recovery: This signals an overheating economy and will cause the Fed to raise rates, choking off any further growth.
• The Fed is beginning to increase short-term interest rates: This is further proof the economy is overheating. The rise in interest rates will crush any chance of further growth in the stock market.

Here’s the kicker – Mr. Positive and Mr. Negative are the same person. It’s just that his attitude has changed due to the shift in positive or negative sentiment (pendulum swing). Take 2018 for example – what’s really changed in the last few months? Not really that much. The economy is still very healthy, unemployment remains low, inflation is still pretty tame, rates are still rising (although they are still low by historical standards). Sure, there are geopolitical tensions, but when is that not true?

During a positive sentiment swing there’s almost no news bad enough to bring down stock prices. And during a negative swing no news is ever good enough to push stock prices higher. It seems almost impossible to gain any momentum. Then one day, without any warning, the pendulum starts to swing the other way. And it seems like it will never swing back.

Unfortunately the ups and downs of the market can’t be stopped, because the “market” is Us. We are humans, and humans are emotional and sometimes irrational. The good news is that, over the long run, the stock market functions in a rational way and rewards investors for their patience. Company fundamentals do matter, and stock prices tend to reflect this over the long-term. Otherwise, why would we invest?

Now, in the short-term, prepare for wackiness!

Sometimes these pendulum swings, either positive or negative, can reverse in the blink of an eye. And sometimes they can linger for longer periods of time. Unfortunately for us investors, we just have to accept it as normal. For now, welcome to Bizarro World.