Kass’ position was that they are often not. I am found of saying the market was as wrong at Nasdaq 5000 in March 2000 — earnings didn’t matter, its a new paradigm — as it was with Nasdaq at 1100 in October 2002, when profitable debt free companies were selling ofr les sthan book value, and in some instances, less than cash on hand.
Shedding some light on this is David A. Rosenberg, Merrill Lynch’s North American Economist. Rosenberg looked at whether a recession could begin with equities at or near all time highs.
The answer, surprisingly enough, is yes:
"The S&P 500 peaked on July 16, 1990 after a 3.4% burst over the prior month and the recession began that very same month. Go back to February 13, 1980 and you will see that the market peaked and came off a huge 7.8% melt-up in the previous month – and the recession had begun the month before. . .
What we do know is that the economic backdrop has become worse, not
better. Over 90% of the economic data have come in below expectations
in the past month and our internal Data Diffusion Index has hit its
low-water mark for the year . . . "
Stock markets are not always perfect discounting mechanisms:
Source: Merrill Lynch, Standard & Poors
As Jack McHugh points out, many investors seems to think a recession
would either be bullish (because the Fed would continue to ease) or
would be an impossibility (because the stock market, "discounting
mechanism" that it’s supposed to be, is hitting new highs). And he notes that markets also peaked in 1929, even though the highs were seen a couple of
months before the onset of the Great Depression.
"I suppose it’s
possible that the price-worshiping, momentum crowd has it right and
that nirvana lies just over the horizon. Given the worsening problems
in housing and mortgage finance, however, it’s possible, just maybe,
that the quantitative model-builders in equity land will prove to
possess no more genius than their fixed income cousins displayed when
constructing subprime CDOs."
Discounting mechanism, indeed.