The asymmetry of market rises and falls

The financial markets are largely moving sideways, neither strongly up, nor strongly down.  In my opinion this is a proper response to unexciting economic and business news.  Firmly stated, stock markets are fairly, to slightly over-valued at this point.  This provides a convenient backdrop for today’s post which I hope serves as a cautionary tale.

In life to create something wonderful and innovative takes tremendous effort and typically many years.  Take for example that symbol of modern fabulousity, the iPod.  The perception is that Apple’s iPod was an overnight success.  However, the electronics that went into it had their first germination in the 1950s.  It took over 50 years for a hard drive to be small enough and have enough storage on it and to be cheap enough to make the iPod feasible.  Additionally, the digital technology that lies behind music storage took nearly two decades to create, culminating with the release of Compact Disc technology in the early 1980s.  Then it took the Internet from 1969 until the early 90s to be a viable digital network that was accessible to the public.  Then a large majority of consumers needed to have high speed Internet connections in order to make music downloading viable.  Then finally Apple had to establish licenses with the major music companies (which took years) in order to launch iTunes.

This same sort of process, writ large, takes place across the economy and is the bedrock of what I frequently refer to as real economic growth.  Attaching one’s capital to this real economic growth is the goal of every investor as it generates real capital appreciation.  Apple’s meteoric rise to recently much-favored Wall Street stock took almost two decades.  Prior to the iPod Apple was seen as the also-ran in the battle for personal computer supremacy, having lost out to the combination of Intel and Microsoft.  My point is that it takes years and years to make money as an investor, whether you are Apple investing in the iPod, or Joe Doe investing in the stock market.

By stark contrast, a loss of year’s worth of value in the stock markets can take just a few trading sessions.  Yes, there are stock market bubbles, but those typically take several years to inflate.  But when the bubble bursts it does just that.  As an investor it is easier to participate in the inflation of a stock market bubble than it is to avoid a precipitous stock market fall.  This is the asymmetry of market rises and falls.

So where are we now?  The stock markets had a dramatic lift-off last year post their March 9, 2009 lows.  That singular, once (or twice) in a lifetime rise was to correct what was a massive overselling of equities.  That sell-off was pricing in a Depression and not an extended, deep recession.  But now the stock market has rise from its ashes and now manuevers sideways as valuations are full.  A rise from here requires an unambiguous stream of positive news, yet there is no catalyst for exclusively positive news.  In contrast, as I survey the intuitive landscape of prospective triggers for catastrophe they seem large.  For example, a continued problem with unemployment (which is likely) will stall consumer spending and will lead to a stall in the economic recovery, if not a fall back into recession.  A Middle Eastern conflagration (e.g. in Iran) would cause a massive sell off in equities and send commodities prices dramatically higher.  A lack of new capital flows to business (read: consumer spending) will lead to a lack of innovation in U.S. businesses, leading to lower profits, leading to poor earnings results, leading to a stock market sell-off.  And on and on.

My singular point of this post is to highlight that we are much closer to a rapid sell-off in the stock markets than we are to a rocket-style liftoff.  I am quite comfortable in cash or low-investment quality bonds right here.

Jason