It never ceases to amaze me how the media will supply a every day explanation as to what drove the stock marketplace higher or lower. When is the last time you saw a headline that simply read “Stock Market Rises 100 Points – No Identifiable Catalysts”? Unfortunately headlines are notoriously much more volatile than the stock marketplace itself as they’re typically driven by short-term surface level marketplace movements and the need to supply some thing attention-grabbing.

At the end of July, headlines emphatically declared that the marketplace had its greatest one-month performance of the past year and was once again off to the races. But just eight days later, they reverted back to concerns about the health of the V-shaped recovery and questioning whether July was in fact just a head fake. This weekend, editorials increasingly discussed the growing fear that a prolonged downturn within the economy could in fact lead to what may be the most feared of all scenarios, deflation, which would result in low growth and high unemployment for a protracted period of time. If you bought and sold based on these headlines, you would almost definitely under-perform the marketplace by a wide margin; buying whenever you should be promoting and promoting whenever you should be buying.

Looking past the headlines, what can we learn by focusing directly on investor preferences throughout the July rally? Using the Market Topographer® benchmarking platform that my colleagues and I at OCE Interactive developed to explain what drives relative valuation of stocks, we were able to see that although the S&P 500 rose 9% in July from its intra-day low, much of the risk aversion that crept in over the prior two months still seems to linger. You can see this within the outsized premium the marketplace continues to afford stocks sporting high dividend payout ratios and low financial leverage – both remaining well above 20 year averages – and the historically low differentiation it is assessing based on Wall Street’s expected long term earnings growth rate.

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On the economic front, earnings continue to be dominated by inventory restocking as opposed to consumer purchases which are necessary for a recovery to be sustainable. And recent surveys of institutional investors suggest investors are increasingly becoming concerned once again about economic deceleration and most disconcerting the possibility of deflation. Aversion to financial leverage and most notably, the market’s strong preference for the safety of dividends even when faced with a scheduled increase in taxes on dividends likely around the corner, sure seems to suggest the marketplace could be preparing itself for such a scenario.

Combine this with a sharp increase within the premium for September VIX futures, and the rise within the marketplace from the lows achieved on July 1st appears to have been much more attributable to the correction of an oversold marketplace than a rejuvenation of the rally.

Of course, I hope the marketplace can shake off the Fed’s less than optimistic assessment of the economy reconfirmed yesterday and can resume July’s upward trend. And it’s possible that the press was correct two weeks ago when it suggested the rally was back. Then again, continued evidence seems to strongly suggest that the press was much more likely correct this past week. But one thing is pretty certain. If past experience is a guide, a sustainable rally will ultimately be accompanied by a renewed preference for growth versus dividends and less aversion to financial leverage. And for that to happen, we will need to see renewed signs that the economic recovery is once again regaining steam or at least indications that the deceleration has once again floored.

Conclusion? I would suggest investing with caution over the next couple of months and studying closely the type of stocks that are rising or falling, whether with a sophisticated platform like Market Topographer® or by simple observation. And definitely do yourself a favor. Whatever you do, don’t invest based on the headlines!

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