(By Kevin Donovan) Imperfection being the constant of the human condition, equity valuations are always undershooting or overshooting, kind of like our putting stroke. This condemns investors to watching our old pal Sisyphus push the rock uphill only to see it roll down again. This is what economists, lyrical souls that they are, call "reversion to the mean."
So, whether pondering the futility of our golf game or the arc of stock prices, one asks: "Where is that damn rock headed?"
To answer this, we are faced with another conundrum. It can be said that equity valuations are predictors of corporate profitability, which, in the aggregate, depends on economic growth. Those valuations should adjust as evidence accrues one way or the other. This is what finance professors, ever the blithe spirits, call the "discounted cash flow or dividend discount model."
But, as Mitt Romney was laughed at for averring, corporations are people. If they depend on economic growth for wealth creation, they must – like each butcher, baker and candlestick maker who makes up the economy – be doing the growing themselves.
Or, in the words of another presidential candidate, the sage possum Pogo of yesteryear's funny papers, "We have met the enemy and he is us."
Which leads us to yet another riddle (Bear with us; fearless predictions will be forthcoming). If we assume the market never gets it right, our task is to divine in which direction the rock is undershooting or overshooting. This is what Wall Street wags mean when they say, "Nobody rings a bell at the top."
We find it our task, then, to stand athwart the midpoint of 2012 and judge the direction of economic growth and its doppelganger, the rock on the hillside. As always, the evidence is inconclusive, but try we must and, again like Sisyphus and our erratic putting, take pleasure in the effort if not its result.
First, let's put the concerns of this vale of tears into four buckets in order of significance:
The Old World: Europe is falling into recession. Greece is a mess. Spanish unemployment is 24%. The break-up of the Eurozone appears imminent.
The New World: U.S. real GDP growth slowed to a 1.9% annual rate in the first quarter. Jobs growth has plummeted from 200,000-plus per month in the winter to just 69,000 in May. The "fiscal cliff" of 2013 looms.
The Orient: China's gallop has slowed to what for it is a trot, with GDP growth at "just" 8% or so.
The Golf Course: Can we build a repeatable swing?
Next, let's parse these concerns and spy which way the rock will rotate.
The Old World: Germany, already caving to the growth advocates, will accommodate them further. The European Central Bank will cooperate. Italy's technocratic compromise, though far from the best of all worlds, will be copied.
The New World: Romney could very well be president and inherit a recovering economy (the very one he is running against, reminiscent of Bill Clinton's good fortune in 1992). If Europe can muddle through (see above) expect the rock to signal economic growth. Whoever is elected, we can't believe politicians will be so thickheaded as to let sequestration and tax hikes to kick in January 1.
The Orient: China may be the model for the rest of the policy makers in the civilized world. With inflation slowing, the authorities have plenty of room to address slumping growth. The central bank recently cut interest rates for the first time since 2008, and the government is looking to ramp up public investment projects.
The Golf Course: Head down, eye on the ball, turn in a barrel, all without thinking about it.
Our conclusion: Buy the dips and take one more club than your ego tells you. Sisyphus would do no less.