What’s Our Market Have to do With the Price of Rice in China?

by Ron Ianieri | July 29, 2010 8:07 pm

Much is being made of the divergence between the stock market and the economy. Earlier this week, CNBC’s Mark Haines asked how is it that the market can be doing so well while the economy is supposedly doing so poorly.

Haines is not alone. Most analysts, commentators, economists, traders and investors are at a loss to explain how and why this divergence phenomenon is occurring.

I, for one, think I have the answer to the question that others haven’t been able to answer. It is not because I am necessarily smarter. It might just be that I do not believe that there is a divergence. I believe there is a decoupling.

The conventional wisdom goes that the economy lags the market by six months or so, inferring a connection between the two. The government has been using this “fact” to try to keep people optimistic. Big brother pushes the belief that the economy is reflected by the market, i.e., good market, good economy.

Studies show that the average Joe believes that if the market is recovering, then so is the economy, albeit on a six month trailer. The problem is that the market started to recover almost a year and a half ago! Yet, even as the market recovered, the economy is no better than it was then, and maybe even a little bit worse.

Here is where the divergence lies: The market has recovered largely on the shoulders of better-than-expected earnings, but the economy is still stuck in the doldrums. It sure seems like the market is marching to the sound of a different drum (maybe an Asian drum).

So, the answer to Mark Haines’ quagmire is that the market is following the economy … the Asian economy! There is no divergence; there is a decoupling from the U.S. economy and a coupling to the Chinese economy.

Thanks to the rapid globalization of world economies, many of the larger corporations here in the United States developed solid and strong lines of distribution in most countries around the world. Mind you, we are talking about the biggest of the big companies — Fortune 500 types — the ones that are reporting all of these good earnings. These are the companies whose stocks have benefitted the most. They also happen to be the ones that are best represented in the major indexes. They are the ones that are the most heavily weighted in the indexes and, therefore, have the biggest effect on the market.

So, with all of that taken into account, it is no wonder why so many of us are so confused with how well the market is doing considering how poorly the U.S. economy is doing. The major market movers, the biggest companies with the heaviest weighted stocks have simply hitched their wagons to a different economy — the Asian economy, specifically China.

This may seem a little far-fetched to you, but there is more concrete evidence backing my theory. Just released information shows that for the first time in its history, the United States is NOT the biggest buyer and user of energy — China is!

So what does all this mean to U.S. investors?

It means that we may never see our market match our economy as closely as we have seen in the past. It means that there will always be good stocks to invest in even when our economy suffers. But it also means that our market will react more strongly than ever to economic conditions abroad, especially in China. And if China starts to hit the skids before we return to some semblance of what we were, the market will probably suffer greatly even if things here have not gotten any worse.

Many of you bears out there who have been waiting for our market to trade down to match our economy may be in for a long wait. Many of you who have been waiting for our economy to recover taking a clue from the market may find that our economy does not lag the market by six months as so many analysts and commentators on TV have stated. It has been decoupled, so there is no lag, and the market is not offering a glimmer of hope for our economic recovery starting soon, let alone at all!

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