Markets do not care about you.  They don’t care about your family, your feelings and they particularly don’t care about your wallet.  With record deficits, QE2, 9.4% unemployment, continuing stimulus and 0% interest rates many are still baffled by a surging stock market.  What gives says the Main Street investor?  Clearly, there’s still an enormous disconnect between the market and reality.  I know, there are a lot of positive signs out there, but the fact remains – Main Street still doesn’t feel like the recovery is headed their way.  But the market isn’t the economy.  Main Street isn’t Wall Street.  And the market is a heartless beast that desires one thing and one thing only- PROFITS!

Although we live in a world of the Bernanke Put and endless government bailouts the markets remain the last bastion of natural selection in the modern world.  When allowed to truly function on its own capitalism is a cruel, heartless, but remarkably efficient bitch.  The weak ultimately perish and the strong survive.  For the strong the rewards are great.  For the weak the losses are insufferable.  And in this world of cruelty you must never forget that the system has no sympathy for you or your emotions.

The equity market is priced based on future profit expectations that are often right, but more often than not prove to be wrong.  As we saw in 2007 those expectations were high, investors believed economic downturn would be thwarted and the environment ultimately surprised substantially to the downside.  As the waterfall decline ensued we experienced the inverse reaction in 2009.  Markets and expectations overshot to the downside.  Expectations for profit growth became far too low and classic mean reversion ensued.  As the economy stabilized in 2009 the economy remained stagnant at best.  But the economy’s loss had become corporate America’s gain.  The massive cost cuts made these corporations lean and mean.  Corporate America’s diverse revenue stream kicked in as the global economy strengthened and leveraged up these lean balance sheets.  Despite persistent weakness in the US economy profits continued to rebound through 2009 & 2010 even as US unemployment continued to climb.  That heartless bitch did not care about the unemployed, stagnant wages or l-shaped recoveries.  She cared only for the bottom line and the bottom line was robust – particularly when compared to expectations.

Over the years I have attempted to measure this disconnect between perception and reality using my Expectation Ratio.  The metric was bearish since 2007 and was then bullish throughout the majority of the recent bull market. If I have made one mistake in recent years it has been focusing on what should be good for an economy (job growth, fair markets, organic growth, etc) as opposed to what the market desires (higher profits no matter how they come). But much like an approach to trading, your approach to conducting research must be unbiased, flexible and mechanical.  Ultimately, the purpose of research is to generate investment profits.  Connecting the dots between this research and actionable ideas is vital to success.  If you allow the emotion of a macro outlook to infect your work your results will suffer.   Remember, the market is not the economy.  The market does not care about the emotions of the unemployed or the suffering.  In fact, she feeds off the negative emotion and it is often not until you have become comfortable and complacent that she will turn her back on you and break your heart again.

As investors we are always learning, evolving and honing our skills in order to avoid the pitfalls that cause so many to self destruct. Few investment cycles have been as great a learning experience as this one.  We live in a renaissance for economic thought, economic theory and investment.  It’s unlikely that we will experience as many beneficial learning experiences as the most recent cycle.  And while this environment continues to cause great pain there are also great lessons to be learned.

From an investment perspective, there has been no greater lesson than the fact that has been burned into my soul from the last 24 months – the market is not the economy and the market has no sympathy for you, your family or your emotions.  She desires one thing and one thing only – profits.  And those profits will often come at the expense of everything we wish for in this world.  That’s the cruel reality of the capitalist system in which we reside.  It might not be fair, it might not be right, but it is what it is.  In the end, capitalism continues to be the most dynamic, innovative and productive system in the world.  But make no mistake – that system does not care about you and anyone who forgets that will be devoured by it.

Cullen Roche

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