Friday, May 7, 2010

What In the World is Going On with Stocks?

This week has provided yet another perfect example of why so many people hate the stock market.

For the first four months of the year business conditions have been improving pretty steadily.  Bailed out corporations like General Motors and many banks have retooled and stabilized and paid much of the money back to taxpayers.  When Barack Obama became president, the world faced an imminent and obvious financial crisis.  The U.S. job market was shrinking as more than 150,000 more jobs were being eliminated than were being created every single week for months on end.

Today it was announced that during April, almost 300,000 more jobs were created than were lost.  That's a net gain of more than a million jobs per month from where we were a year ago. Company after company has announced improved profits based on growing sales and reduced overhead. 

The stock market seemed to be right in synch with the improving reality.  After posting large double digit gains last year, most market averages were up nicely for this year just a few days ago.  On Monday of this week, all the major indices rose more than a full percent.  Things seemed on track.  Now just a few days later, in the absence of any apparently earth shaking news and without warning everything has seemingly changed.

On Tuesday, the bottom dropped out of the stock market and just two days later full blown panic set in as the Dow dropped almost 1,000 points in less than an hour before it came back to fall "just" 347 points for the day.  All of the gains that most accounts had built up in 2010 have been erased in just a few days.

The analysts and experts have been clueless.  No one has yet been able to explain the cause of the 1,000 point roller coaster ride.  Most have chosen to blame the overall carnage on computer glitches and news about credit problems in Greece--problems that have been around and in the headlines for months and which on their face just don't seem to be big enough to warrant the rout and panic that have hit the markets with a vengeance.  It appears that the experts don't have a clue what is going on in the stock market so they are grabbing at any news headlines they can find.

On the positive side, the market selloff this week has caused investor sentiment to shift from complacency to outright panic.  The violent swings of the last few days have looked and felt like forced selling from funds and investors just throwing in the towel without regard to price.  This type of capitulation tends to almost always take place at market bottoms--not in the early stages of a protracted bear market. 

It also shows that even though the market has been in solid rally mode for more than a year, most investors have never really trusted the move.  They just have too many bad memories and the news about deficits, unemployment, and foreclosures have just been hard to ignore.

Skepticism and fear are typically bullish signs because it shows that many investors are still afraid of stocks.  The market, like a dance floor, fills up fastest when lots of people are sitting on the sidelines waiting for a song they like.  Once everyone is dancing, the floor can't get any fuller--it can only empty.  But if the dance floor is already pretty empty, the downside is more limited.  That's why high levels of investor fear are viewed as a bullish sign while complacency can be a harbinger of trouble ahead.

Certainly there has been no fundamental shift in the earnings or prospects for most companies during the last few days.  And yet many of those companies have lost 20 percent of their value or more despite the fact that their recent earnings reports and outlook have been quite upbeat.  Either these stocks represent attractive value at these levels or something very bad is about to happen to our economy that we just can't see or feel right now. 

There is always a chance that the economic disruptions in Greece will spread throughout Europe and eventually to our country as well.  There is also legitimate uncertainty and concern about the huge deficits that are being racked up by the U.S. Government and what economic consequences will ensue.  But it seems like a doomsday scenario is already being priced into the markets long before it is clear that the current uncertainty will lead to widespread economic problems.

One other complicating factor may have been the proliferation of "super sized" Exchange Traded Funds (ETFs) that have become increasingly popular with many investors.  ETFs grew in popularity as a way for ordinary investors to participate in specific market sectors, indices, or geographies in a quick and easy way.  But in recent years, the most popular ETFs have been a broad range of "funds on steroids" that provide a way to make leveraged bets with 2 or 3 times the "pop" of  simple vanilla index funds

As a result, individuals now have the ability to make riskier bets using the kind of leverage that used to only be available to larger institutions.  A byproduct of that approach is greater volatility at all times but particularly during buying and selling panics when everyone is trying to get through a small door at the same time.

At the end of the day, it seems prudent to move assets away from those markets which might be less resilient to these disruptions and also away from the overweight positions in basic materials which are vulnerable to the impact of the rising dollar which has been moving up against the currencies of countries that are in even worse shape than we are.

But generally speaking, I remain upbeat on the U.S. stock market in general and technology, pipelines, credit card issuers, and some financials in particular.

There is a risk that the disruptions in Europe and elsewhere will grow into a huge economic problem that will cause people to stop buying new TVs and new I-Pads and will slow down business in general.  There is also a risk that the long-predicted financial calamity will play itself out as the consequences of huge deficits, major unemployment, and widespread foreclosures come home to roost.

But it seems the bigger risk would be to sell good companies at what seem to be low prices only to watch prices rise dramatically when the sense of panic lifts.  I'm just not convinced that the companies that have done so well over the last year and are forecasting more growth are facing a huge setback due to forces that are hard to see clearly on the horizon.

People should never put money they are going to need over the next few years into stocks.  They should also keep as much additional money out of harm's way to enable them to sleep at night during weeks such as this.  But for investors with a long term horizon and a tolerance for some risk and volatility, it seems we remain in a time of great opportunity for growth across a broad range of companies and sectors.


Norwegian Shooter said...

I wish I had enough money so that I didn't need all of it for the next few years. If I did, I'd put it all with you. How did you become so sane?

Larry Gellman said...

Thanks Shooter. I'll wait for your call.