Opinion: The stock market will rally once the drama of 'The Presidential Apprentice' fades – MarketWatch


George Soros is a great investor, not only because he made a lot of money in the financial markets, but because he also has a rare combination of skills: He is a great trader and a great analyst.

In my experience, most good traders are not the greatest longer-term thinkers and most analysts are not the greatest shorter-term traders. He is both. While wearing his analyst hat, Soros came up with the “theory of reflexivity,” which goes like this (as explained by Investopedia):

Earnings have accelerated in a very mature stock market and economic cycle, which is almost unheard of.

Reflexivity theory says “investors don’t base their decisions on reality but their perceptions of reality. The actions that result from these perceptions have an impact on reality, or fundamentals, which then affects investors’ perceptions and thus prices. The process is self-reinforcing and tends toward disequilibrium, causing prices to become increasingly detached from reality.” (Italics added for emphasis.)

Read: Earnings have been causing more stock volatility than normal this year

The 2008 financial crisis was an example of that. The perception was that U.S. housing prices would keep rising, so financial vehicles made up of subprime mortgages could be safe. Prices kept rising until a bubble was developed and then, suddenly, it popped.

It’s important to note that reflexivity theory runs counter to mainstream economic theory, which says people are rational and free markets price assets correctly, resulting in equilibrium.

Stock market disequilibrium

How does that pertain to today? We now have truly bizarre reflexivity: The stock market has tumbled while many companies’ earnings growth is accelerating. In a normal environment, accelerating earnings mean rising share prices. Here we have the opposite.

Stock investors may be worried about World War III or a trade war with China and the rest of the world, which could clearly outweigh an acceleration in earnings.

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Be that as it may, if such undesirable outcomes are avoided, prices can decline only so much in an accelerating earnings environment. Declining prices with accelerating earnings typically result in a coiled spring, or “beachball under water,” effect that ultimately ends up correcting itself to the upside.

Pictured here is the S&P 500 Index SPX, +0.18%  (blue line) with forward 12-month earnings per share estimates, which have now climbed above $160, an all-time high. So far, with only about 17% of S&P 500 companies reporting as of April 20, earnings growth for the quarter is running at 18.3%, a very high rate. So earnings have accelerated in a very mature stock market and economic cycle, which is almost unheard of.

Earnings tend to grow the fastest in the early stages of an economic recovery because they get depressed during a recession, so it is easier to grow faster from a smaller base. Now we have record profit margins in the S&P 500 and late-cycle acceleration. Some of it is due to the concentrated global recovery, but a lot of it has to do with the Trump tax cuts, which have basically left more money to circulate in the economy and have increased the profitability for the economy at large.

‘The Presidential Apprentice Season 2’

As I have mentioned previously, if Trump manages to denuclearize the Korean peninsula, rebalances the hopelessly out-of-balance U.S.-China trade relationship, and pulls out of Syria without starting World War III, he will be revered as much as Ronald Reagan. But because of his chaotic nature, many are missing the fact that he is executing on his election promises with consistency.

Still, it would be best if Special Counsel Robert Mueller finished his investigation with the findings that Trump has not been compromised by the Russians. But, as James Comey said last week, it is possible, however unlikely, that Trump has been compromised. Comey should know, as he ran the investigation before Mueller took over.

I have dubbed Trump’s first year in office “The Presidential Apprentice Season 1,” since he was learning on the job with a high turnover of key administration officials. So far, his second year in office can be called “The Presidential Apprentice Season 2,” with significantly more drama than season one.

CNN has become far more entertaining to watch than any reality-TV show, including the original “The Apprentice” itself. The twists and turns of an adult-movie actress and a Playboy model suing the president have become convoluted, magnified by the legal battles of Trump’s own personal legal team after the FBI raided his office and residences.

If all this CNN drama can be reduced to normal levels, the stock market will likely rally, based on economic fundamentals. Still, if one were to borrow an eloquent phrase from Comey, it is possible, however unlikely, that “normal” may not exist in the present situation.

Normality may just be my wishful thinking.

Ivan Martchev is an investment strategist with institutional money manager Navellier and Associates. The opinions expressed are his own.