An Extraordinary Journey
For the last two months, stock markets worldwide have been cascading down in an unremitting collapse. Fear has been as high as we've seen in the markets in decades. We know that the outcome will not be good; the question is how bad it will be. Most predictions now are dire. Talk of catastrophe and comparisons to the Great Depression come easily. But does this financial market collapse of necessity spell doom for the world economy?
This summer a friend reported hearing this on television: "If you think you understand what's going on in the market, you're just not paying attention." Generally prognosticators sound confident even though we know that it is impossible to guess the future. The current period has been so out of the norm that few people could anticipate even the broad dimensions. Alan Greenspan has called this period a once in a century financial crisis. It's certainly bad. While we can't predict the future, investors have to make decisions. It might be a useful guide to take stock of what has happened and what we do know.
First, let’s look at the damage. Bloomberg reported today that this month alone $12 trillion of global stock market value has been eliminated. The S&P 500 has dropped 26 percent in October as of Oct. 28. In one week in September, the S&P dropped 18 percent, an all-time record including the Crash of 1987 and the Great Depression. As is frequently the case in bear markets, volatility has been extremely high. Swings up and down in the market have been the most violent since 1932. Quantitative measures of fear globally have been at record levels. Anecdotal measures of investor fear such as magazine covers, TV and newspaper coverage and our conversations with people who don't follow the market, confirm these measures. Today consumer confidence reached an all-time low.
The cascade downward has created a vicious cycle. As investors grow fearful and pull money out of mutual funds or other vehicles, those funds have to sell stocks. This leads other people to pull money out and the feedback loop continues. Yesterday, several people asked me what, if anything, can stop this vicious cycle?
Several things can stop the selling but there's no telling when they will kick in. A useful comparison is to picture a forest fire out of control. The fire will certainly stop when it runs out of fuel. It could also stop when the wind shifts, when there's rain or through the efforts of fire fighters. Each fire is different and we don't know how much damage they'll cause but they all stop at some point.
In the case of the markets, often times the selling burns out of its own accord and there’s no particular reason why it stops at a given time. An example of this type of spontaneous rally occurred in July, 2002, with no good reason for the rally. This time we've already had a record burn so maybe it will run out of fuel soon.
Sometimes what arrests the selling is when value investors with cash believe that valuations are irresistibly cheap and jump in. We've already seen selective instances of this with Warren Buffet making high profile investments in Goldman Sachs and General Electric and Bill Gross of Pimco, the largest bond investor, selectively making purchases.
By some measures, valuations in world equity markets are the cheapest in two decades. This lowers the risk of investors coming in now because the stock markets are discounting lots of calamities already. However, veteran investors know that what's cheap can get cheaper.
Once the fear subsides -- and it's hard to maintain an intense level of fear for more than a few weeks -- investors will note that competing investments are not attractive. U.S. Government bonds are yielding little by historic standards. Other potential competitive asset classes such as residential and commercial real estate and commodities also have diminished appeal now.
The record interventions by governments around the world this fall have been truly spectacular. Central banks have lowered interest rates as well as using creative strategies to flood the world with money. Government fiscal policies also have quickly adapted to the new realities. The effects of these policies are never visible for months and that always prompts doubts. In each cycle people say the Federal Reserve isn’t having an impact and each time it does.
While the news is grim now, we can recall other times when the news seemed overwhelmingly bad and remember that markets recovered then. After 9/11, the U.S. stock market was closed for a week and then dropped sharply. But little more than a month later, in early November,
2001, the market staged a good recovery. While the U.S. had a recession, it was not nearly as severe as seemed likely that dreadful September day.
In late summer of 1998, it seemed that the world financial markets would seize up. After a full year of emerging markets contagion, in August, 1998 the S&P 500 fell 15 percent, Russia defaulted and Long Term Capital failed. After a brief recovery in September, the market fell again hard into mid-October. A well-known television market personality warned that investors should sell everything. Once again, it seemed that the markets and economy were cooked but both staged rapid recoveries globally.
In short, we'd suggest that investors accept that much of the damage has already been done. We can't predict whether the bottom has been reached or what shape a recovery will take. But we would suggest that the world economy will continue to function and that in time, the financial markets will reflect that. Over the years, including the Depression, the broad U.S. stock market has returned 10 to 11 percent on average and global markets have been a little higher. For money that's for the long-term, five years or more, this is likely to be a good entry point for people investing in widely diversified mutual funds or other vehicles. For money that's needed sooner, the stock market is experiencing an unusually volatile period and there are probably better homes for that short-term savings.
Tuesday, October 28, 2008
Thursday, October 23, 2008
A Coiled Spring
The Dangers of Market Timing
One of the special dangers of market timing moves now is that we are in a period of very rare and unusually rapid events. By one measure, the daily swings in the stock market are the biggest since September, 1932. The worldwide drop is the most in such a short period in history. In another case, one numerical measure of fear that goes back 15 years, is at its highest point ever.
Given this backdrop, we are operating in the rarefied air of historically unusual outcomes for the stock market. The natural tendency is to assume the recent trends will continue: that would mean a continued drop for the indefinite future.
Right now, the market is like a coiled spring that could snap back a considerable way in a hurry or break from the pressure. There's no telling which way it will go although historical precedent would suggest that it's more likely to bend than break.
Since the downside threat is readily apparent to most people, let's turn to an unusual example on the upside. In the spring of 2001, a year after the tech bubble peaked, the broad stock market took a severe down leg culminating in a sharp, fear induced collapse in late March. Within two weeks, the Nasdaq Composite rallied 33 percent before starting a slow drift downward over the summer. After the attacks on 9/11, the market dropped sharply for a week after it reopened, then in late fall began a sharp rally. The market then traded in a narrower channel until March 2003 before staging a significant rally that lasted four years.
The point of this look at market history is to point out again how difficult it is to anticipate stock market moves. Waiting until the all clear sign becomes apparent is a good way of staying perpetually on the sidelines and missing out on the general market up trend.
I am not so optimistic as to suggest that no dangers remain in the economy or the market. Far from it, disaster scenarios are readily apparent. Still, it would be good to keep in mind that these periods of turmoil also breed opportunities for investors.
One of the special dangers of market timing moves now is that we are in a period of very rare and unusually rapid events. By one measure, the daily swings in the stock market are the biggest since September, 1932. The worldwide drop is the most in such a short period in history. In another case, one numerical measure of fear that goes back 15 years, is at its highest point ever.
Given this backdrop, we are operating in the rarefied air of historically unusual outcomes for the stock market. The natural tendency is to assume the recent trends will continue: that would mean a continued drop for the indefinite future.
Right now, the market is like a coiled spring that could snap back a considerable way in a hurry or break from the pressure. There's no telling which way it will go although historical precedent would suggest that it's more likely to bend than break.
Since the downside threat is readily apparent to most people, let's turn to an unusual example on the upside. In the spring of 2001, a year after the tech bubble peaked, the broad stock market took a severe down leg culminating in a sharp, fear induced collapse in late March. Within two weeks, the Nasdaq Composite rallied 33 percent before starting a slow drift downward over the summer. After the attacks on 9/11, the market dropped sharply for a week after it reopened, then in late fall began a sharp rally. The market then traded in a narrower channel until March 2003 before staging a significant rally that lasted four years.
The point of this look at market history is to point out again how difficult it is to anticipate stock market moves. Waiting until the all clear sign becomes apparent is a good way of staying perpetually on the sidelines and missing out on the general market up trend.
I am not so optimistic as to suggest that no dangers remain in the economy or the market. Far from it, disaster scenarios are readily apparent. Still, it would be good to keep in mind that these periods of turmoil also breed opportunities for investors.
Tuesday, October 21, 2008
Stock Market Milestones: Dow 10,000
After the Deluge
Many people worry that this will be one of those periods when the stock market doesn't advance for many years. In the middle of a worldwide global panic which included a record-setting down week -- exceeding even the Depression years and the crash of 1987 -- that's not a farfetched concern.
Many people still active in the stock market remember the 16-year period from 1966, when the Dow reached 1,000, and then remained below that level until the recession of 1982 ended. If that dismal history to repeats, at least we've covered a lot of that ground already. The Dow reached 9,200 on May 13, 1998 and is at that level as I write on Oct. 21,2008. For more than ten years, the Dow has gone nowhere. Of course, a year ago, on October 9, 2007 the Dow set an all-time record of 14,164.53.
What will determine the stock market's future is what happens to the global economy. Considerable damage has been done over the last year and danger signs are still flashing. Most observers expect a global recession that could be quite severe.
For a stock market that has dropped 5,000 points in a year, discounting a lot of trouble, the most relevant question might be what comes after that? Even assuming a recession, the stock market may already have discounted much of the damage. But afterwards, will the economy recover or remain in the doldrums for a prolonged period?
Under all but the most gloomy scenarios, the market should start to make a significant recovery in the next year or two if not sooner. Anything more protracted would rival the stagnation during the Depression or that of the 1970s stagflation for the longest period where the stock market made no progress. While possible, that is close to a worst case scenario. With proactive monetary and fiscal policies, we can hope that the worst will be avoided.
Many people worry that this will be one of those periods when the stock market doesn't advance for many years. In the middle of a worldwide global panic which included a record-setting down week -- exceeding even the Depression years and the crash of 1987 -- that's not a farfetched concern.
Many people still active in the stock market remember the 16-year period from 1966, when the Dow reached 1,000, and then remained below that level until the recession of 1982 ended. If that dismal history to repeats, at least we've covered a lot of that ground already. The Dow reached 9,200 on May 13, 1998 and is at that level as I write on Oct. 21,2008. For more than ten years, the Dow has gone nowhere. Of course, a year ago, on October 9, 2007 the Dow set an all-time record of 14,164.53.
What will determine the stock market's future is what happens to the global economy. Considerable damage has been done over the last year and danger signs are still flashing. Most observers expect a global recession that could be quite severe.
For a stock market that has dropped 5,000 points in a year, discounting a lot of trouble, the most relevant question might be what comes after that? Even assuming a recession, the stock market may already have discounted much of the damage. But afterwards, will the economy recover or remain in the doldrums for a prolonged period?
Under all but the most gloomy scenarios, the market should start to make a significant recovery in the next year or two if not sooner. Anything more protracted would rival the stagnation during the Depression or that of the 1970s stagflation for the longest period where the stock market made no progress. While possible, that is close to a worst case scenario. With proactive monetary and fiscal policies, we can hope that the worst will be avoided.
"I'll Miss the First 10 Percent"
When Should I jump Back In?
Over the past month, I've talked to more people about the stock market than at any point in my three decade career. People are angry, confused and worried and justifiably so. With good reason, this is regularly being described as the worst financial crisis since the Great Depression. While we don't know the outcome -- and it could certainly be less severe than the common fears -- the danger of a worldwide systemic problem is undeniable. Only a month ago, this was widely seen as only a Wall Street crisis.
On that basis, the House Republicans initially rejected the administration bail-out plan. Only when they saw it as a "rescue" plan for the economy, did they jump on board. In the meantime, the carnage has been spreading to every sector of the economy and around the world. Businesses, unable to obtain financing and worried about a long economic slowdown, have begun shutting facilities and laying off employees. While no one can forecast accurately, the most likely outcome seems to be a harsh and long global recession.
Given that, what's an investor to do? The natural instinct is to shun all risk and hunker down for the duration. For those investors who have acted on that impulse, it has served them well. Looking ahead, that may not be the proper course of action. One has to separate the economy and the stock market to plan for the future. The stock market usually discounts future expectations by many months. Typically, the market will rebound once the very worst of a recession hits. By the time a recovery is underway, the market generally has surged. In 1991, the broad market was up by 30 percent even though a recovery was not visible in the 1992 presidential campaign and for at least a year thereafter.
What about the idea of waiting for the all clear to sound? We know that it has not sounded yet and we can't even be sure that the worst is over. What we do know is that right now the market is moving back and forth by some of the biggest amounts in history. We also know that it never is clear what the market will do until long afterwards.
It's hard to know when to bail out and we applaud those who did so successfully. It's also extremely hard to know when to jump back in. Managing both is a tremendous feat that is statistically highly unlikely. For most people, we'd suggest that the best course is to judge your investment time horizon and how much risk you can bear and then with that in mind, stay the course.
Over the past month, I've talked to more people about the stock market than at any point in my three decade career. People are angry, confused and worried and justifiably so. With good reason, this is regularly being described as the worst financial crisis since the Great Depression. While we don't know the outcome -- and it could certainly be less severe than the common fears -- the danger of a worldwide systemic problem is undeniable. Only a month ago, this was widely seen as only a Wall Street crisis.
On that basis, the House Republicans initially rejected the administration bail-out plan. Only when they saw it as a "rescue" plan for the economy, did they jump on board. In the meantime, the carnage has been spreading to every sector of the economy and around the world. Businesses, unable to obtain financing and worried about a long economic slowdown, have begun shutting facilities and laying off employees. While no one can forecast accurately, the most likely outcome seems to be a harsh and long global recession.
Given that, what's an investor to do? The natural instinct is to shun all risk and hunker down for the duration. For those investors who have acted on that impulse, it has served them well. Looking ahead, that may not be the proper course of action. One has to separate the economy and the stock market to plan for the future. The stock market usually discounts future expectations by many months. Typically, the market will rebound once the very worst of a recession hits. By the time a recovery is underway, the market generally has surged. In 1991, the broad market was up by 30 percent even though a recovery was not visible in the 1992 presidential campaign and for at least a year thereafter.
What about the idea of waiting for the all clear to sound? We know that it has not sounded yet and we can't even be sure that the worst is over. What we do know is that right now the market is moving back and forth by some of the biggest amounts in history. We also know that it never is clear what the market will do until long afterwards.
It's hard to know when to bail out and we applaud those who did so successfully. It's also extremely hard to know when to jump back in. Managing both is a tremendous feat that is statistically highly unlikely. For most people, we'd suggest that the best course is to judge your investment time horizon and how much risk you can bear and then with that in mind, stay the course.
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