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U.S. Markets Ignore Gloom in the Capital

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Apparently conflicting pictures pose a quandary for market strategists: Should an investor emphasize the negative indicators for the U.S. economy or the upward trend of the stock market?

The U.S. economy may be lurching into another crisis, but you would not know it from the stock market, where an epic party is under way.

Since March 2009, the Standard & Poor's 500-stock index has risen 125 percent. This year, the S.& P. 500 has not fallen for even a single week.

Irrationally or not, some investors who were on the sidelines have become emboldened enough by the rally to start buying stocks, fund flow data show.

Yet this effervescence belies some ominous developments in politics and the economy. After the State of the Union address by President Barack Obama on Feb. 12 -- and the negative reaction to it by many Republicans in Congress -- it seemed quite possible that $1.2 trillion in automatic government spending cuts might begin in a few weeks, delivering yet another blow to an already lackluster economy. Most economists had expected minimal growth this year, even without a new shock from Washington -- or from Europe or anywhere else.

These apparently conflicting pictures pose a quandary for market strategists. Which signals should an investor emphasize: the signs of disharmony in Washington and the negative indicators for the economy or the upward trend of the stock market?

For Laszlo Birinyi, a veteran strategist and longtime market bull, the contest is not close. He says he starts by assuming that the market is smarter than any analyst. "We focus on the market itself, on what it is actually telling us," he said. "We don't worry about the cosmic issues that a lot of people get concerned about. We worry about the stock market ticker. And it's telling us the market is going up."

In September 2009, when very few strategists were overtly bullish, Mr. Birinyi, president of Birinyi Associates, a stock market research firm in Westport, Connecticut, said that the United States was in the early stages of a classic bull market. That analysis was prescient. The S.& P. 500 has returned more than 50 percent since then.

In a conversation last week, he said the country was in the final stage of that bull market. "The bull market probably has between a year and three years to go," he said. "I can't time it. I can only point out the trend."

Mr. Birinyi, formerly chief stock market analyst at Salomon Brothers, uses a combination of quantitative and subjective analysis. He carefully meters money flows into and out of stocks and scours business coverage in newspapers and magazines, which he sees as barometers of popular sentiment.

Money flow, as he measures it, comes from an algorithm he devised at Salomon. "Trades made on a price uptick are treated as buyer- initiated," said Jeffrey Yale Rubin, director of research at Birinyi Associates. "On a downtick, it's seller-initiated."

As Mr. Birinyi put it, "we care about what traders are actually doing with the money." Mutual fund flows are widely tracked, he said, "but they aren't as critical as most people generally think." They tell you how much money is being given to a money manager -- an intermediary. "The critical issue is how that intermediary is actually using the money," he said.

The firm's calculations indicate that in January, net money flows into the stocks of the S.& P. 500 -- as opposed to money flowing into mutual funds -- amounted to $15.6 billion. This compares with a net outflow of $10.4 billion in October, just before market sentiment began to change.

Based on the history of long bull markets -- particularly those of 1962, 1974, 1982, 1990 and 2002 -- such upswings usually have four stages, Mr. Birinyi said. They begin with reluctance, shift to consolidation and then move to "grudging acceptance." The last phase, which he said the United States had just entered, is exuberance: "This is a point where people say, yes, the economy isn't going into recession right away, companies are making money, interest rates are not going through the roof, and all the concerns we have had for some time perhaps were too negative."

He said it was as if people were realizing: "The market isn't like the New York subway system. There isn't another train coming right after this one. This is it, this is the last train. You'd better get on board."

When this exuberance turns irrational and becomes widespread -- when fear is gone and people with no skill in day trading gleefully engage in it -- it is time to run, but that time has not come yet, he said. "There are still problems in the economy," he said. "People are still concerned."

And they may have good reason. For example, the latest threat to the economy was conceived in Washington as a deterrent -- a planned disaster that is never supposed to happen. That is the sequester, the imminent spending cuts that Mr. Obama and Congress set in motion last year. As the president put it last week, "Democrats, Republicans, business leaders and economists" have already said these cuts "are a really bad idea."

Bad or not, the idea was that by legislating a catastrophe that no sane person would accept, the fiscal logjam in Washington would be broken. Well, do not count on it.

The cuts are scheduled to start March 1. The president's speech and the Republican response suggest that the two sides remain far apart. Mr. Obama, for example, called for a "balanced" approach, involving higher taxes as well as some spending cuts. Senator Marco Rubio, a Florida Republican, said that for Mr. Obama, the "solution to virtually every problem we face is for Washington to tax more, borrow more and spend more."

The cuts may subtract about a quarter of a percentage point from the gross domestic product in 2013, assuming that Congress eventually mitigates them, according to an estimate by Michael Feroli, chief U.S. economist at JPMorgan Chase. He now expects G.D.P. growth of 1.9 percent, roughly in line with consensus forecasts. And it could get worse.

Mr. Birinyi does not so much ignore these forecasts as discount them. "The market is telling us it will be a profitable year for many companies," he said. "That's what's important."

There is a 55 percent chance that the S.& P. 500 will reach 1,600 this year, he estimated, and it is likely to keep rising after that. On Friday, the index closed at 1,519.79, within shouting range of its closing high of 1,565.15 reached in 2007.

Asked what is ultimately propelling the market, Mr. Birinyi said, "It's the Fed, always the Fed" -- the accommodative monetary policy of the Federal Reserve and other central banks. Precisely because the U.S. economy is weak, he said, the Fed will keep its foot on the gas, making stocks appealing.

Those who want to know where the market is going, he said, should study the news -- but always "follow the money."


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