The phrase “wall of worry,” currently in vogue in stock-price trend analysis, is an investing chestnut that conveys irony as well as insight.
The metaphor denotes the fact that stock prices can’t rise unless someone is willing to sell. Bad news, it’s said, prompts pessimistic investors to sell and thereby puts merchandise on the shelf for optimistic investors to buy.
Remembering Mike Myers’ Linda Richman character on the old “Saturday Night Live,” the wall of worry is neither a wall nor a worry. Discuss.
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A good example of the “wall of worry” theory is energy stocks, the best-performing sector in the market so far this year.
Goldman Sachs has led the way among bullish forecasters of oil prices, which underlie the long-running rally in energy stocks, and sees an average price of $90 a barrel in 2009, up from $79 currently.
But in a report released Sunday, Goldman said, “we found almost no clients who agree with the Goldman Sachs oil forecast.” Presumably, these clients have been trimming their exposure to energy stocks, creating merchandise for buyers.
Many of the factors that determine the price of oil and subsequent enthusiasm for oil-related stocks are complex. But one factor is simple: the value of the dollar in currency trading.
Oil trades everywhere in dollars. The long-running decline in the dollar against major currencies means a higher per-dollar price for a barrel of oil. In recent days, a stronger dollar has contributed to lower oil prices.
The weaker dollar reflects stronger economies outside the United States and the rise of companion currencies, notably the euro. These trends, if orderly, do not pose a worry to anyone.
A second hypothesis in the wall-of-worry theory is that U.S. corporate profit growth is about to hit the wall. In this analysis, investors scared about widely discussed prospects of slower profit growth in the third quarter, to be disclosed in the days ahead, dump their shares to buyers looking past a brief profit slump.
Based on the price-to-earnings ratio of the Standard & Poor’s 500 index, you could worry that investors have become a bit too exuberant about stock prices relative to recent earnings. But the analysis ignores two key causes of resilient stock prices.
First, there is less stock available to buy, as company after company stages share repurchase programs. Net equity issuance by non-financial companies has declined steadily for five years. The effects of this historic withdrawal of publicly traded equity from the stock market include higher earnings per share for many companies and scarcity value for common stocks regardless of profits.
Second, international demand for U.S. equities blossomed this year to a record high in July, the latest month for which data are available.
The cash from overseas helped offset an apparent loss of appetite for U.S. stocks among domestic investors.
One driver of international investing in U.S. securities is the flood of dollars overseas from the U.S. trade deficit, a force that is little influenced by short-term corporate profit forecasts.
In sum, the flaw in the wall-of-worry theory about the stock market is that the wall is two-dimensional. But there’s nothing pithy in “a dynamic, multidimensional set of opportunities and risks.”
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