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MAKING CENTS OUT OF THE NEWS
Blog #20
(November 23rd, 2008)
ONE THING’S FOR CERTAIN: THE MARKET HATES UNCERTAINTY
By Tom McAllister, CFP™
Uncertainty drives us humans mad! We like knowing where we stand, what is going on, and what is likely to happen. Even if the circumstances are negative, unpleasant, fear-inspiring, or even terminal, we feel better when we feel “in the know”! The stock and bond markets (the sum total of all the humans interested in stocks or bonds), reflect this dislike of matters being “up in the air”. In fact, it can truly be said, “The market HATES uncertainty.” With the market down 40% so far this calendar year, and almost 50% in thirteen months, it seems uncertainty is exacting a heavy toll indeed.
To a large extent, I believe, it’s this sense of uncertainty that’s responsible for the current violent swings in the financial markets. Even when we consider that the U.S. and many of our trading partners are in the midst of a recession or heading in that direction, upon closer scrutiny we must recognize that economic fundamentals are not all that bad.
Corporate cash reserves are at record highs. Corporate earnings, at least outside the financial sector, have been strong, and while earnings will surely decline during the course of the recession, they are not anticipated to plummet during coming months. Unemployment is at 6.5%, which while high compared to recent years, is very modest compared to the 11-13% levels common a generation ago. Most economists think this unemployment, a lagging indicator, will top out in the 7.5-8% area. Overall, these statistics are a far cry from disaster.
Obviously the current administration’s handling of the financial freeze threat was far from adept. Mr. Paulson, whom I generally admire, has proven a poor to mediocre communicator. Paulson’s 180-degree turn (away from buying up sub-prime mortgages and toward direct investments in banks and other financial institutions) may have been justified - perhaps that is the reason Congress gave the administration the power to make that decision. The near-term effect of the change in bailout strategy, though, has been to create more uncertainty, and, as you’ll remember, uncertainty is exactly what the markets hate!
The requested $25 billion bailout of the Big Three auto companies, with its proponents, opponents, and doubters, has created more uncertainty than ever. My own thoughts are that, only with major concessions from all concerned - management, labor, suppliers, bankers and debt holders - can such a bailout be anything resembling a good idea. While the car manufacturers cite the financial crisis as the cause of their troubles, these companies have been slow to fix their terrible quality control, allowing the Japanese and other foreign producers to take advantage of this and to capture market share. Having said all this, I expect Congress will pass some form of auto bailout.
As dramatic proof of uncertainty's influence on the financial markets, immediately following President-elect Obama's choice of Tim Geithner, head of the New York Federal Reserve Bank as his Secretary of the Treasury, the market rallied 6% in two hours! This nomination added a degree of perceived stability to a market that sadly needs some.
What is an investor to do? Most observers agree it is far too late to sell. And, perhaps, it is too soon to buy, although prices are very tempting. My inclination, based on four and a half decades of studying the markets, is to bargain-hunt, committing maybe 10-20% of available funds. Dollar cost averaging (automatic investing of fixed dollar amounts at preset, regular intervals, the kind of investing that happens automatically in pension funds) will surely pay off at these low price levels. Meanwhile, it seems, investors will be getting plenty of practice dealing with their least favorite feeling – uncertainty!
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