Are You Scared of Stock Market Falls?

Today the Dow Jones Industrial Average fell 512.76 points, or 4.31%.

This moment of market turbulence is similar to, though not as severe as, the Great Recession’s big market decline of early March 2009.  The primary similarity is that the “mood of the market” is one of nausea and near panic similar in proportion to what it was then.

The primary difference is that the global economy, especially from the standpoint of businesses and not governments, is much better off than it was in 2009.  Governments are the primary cause of the current turmoil and they are a much smaller proportion of the global economy than are businesses.

When I called the market bottom in 2009 I tracked the “mood of the market” for many days.  Then I waited until I felt a shift in the collective consciousness from nausea to exhaustion.  Then I waited for several consecutive strong up days to “call” the bottom.  What was unique to that moment was that the turbulence and myriad, multiple investor directions all surrendered to a single point: capitulation.

But right now the exhaustion point has not been reached.  That means that more selling off is likely.  And frankly, I have to admit, the wave of selling that occurred today came literally out of nowhere on both the investment and information landscape.  It smells a bit like massive “program” trades driven by large, large momentum investors, more than it does a collective and overwhelming malaise to me.

Yes, it’s true that there are fears that the economy way worsen from here.  Yes, it’s true that the European debt crisis may spread to more countries like Italy and Spain.  However, none of these factors seems more likely today than they did two weeks ago other than the fear of fear.  So the provenance of the selling and its associated panic is mysterious and hopefully not nefarious (blind trades executed due to technical analysis triggers being met).

Is there any logic that can be applied to this problem?  Let’s examine the reasons why and why not to invest right now.

Why would you invest in the stock markets right now?

1. Things are 10% cheaper than they were just several weeks ago.  From a price standpoint this means that shares in businesses are 10% less risky, too.
2. U.S. businesses are reporting good profit numbers.  Caveat: this is performance in the past and the future is what matters (see below).
3. The U.S. debt crisis is 80% resolved.  Details remain, but I am fairly certain that they will be worked out by the bipartisan committee.  If not resolved, the bill that passed on Tuesday (seems so far in the past now) has automatic cuts that are scheduled to take place.
4. The European debt crisis will likely mostly affect Europe, especially Germany, and not the United States.  If Italy and Spain witness government debt failures we are talking about the 8th and 12th largest economies in the world and accountable for $2 trillion and $1.4 trillion of global gross domestic product, respectively.  That’s around 5.7% of global GDP of $60 trillion.  However, we aren’t talking about all of that GDP just vanishing overnight.  Even in the Great Recession most economies only shrank by about 5%, so in Italy and Spain’s case we are talking about a decline of $173 billion.  Certainly not chump change.  But their governments are failing financially, not their businesses.  Thus, you would expect damage of less than the $173 billion figure.

Why would you not invest in the stock markets right now?

1. The debt crisis in Europe looks to get worse.  How investors worldwide will discount/process this is unknown right now.
2. The stock market sell off may further panic consumers which would mean a clenching of consumer spending sphincters and a difficult third quarter U.S. corporate profitability season.  Its hard to tell how the combination of factors is going to play out.
3. Returns asymmetrically look predisposed to the downside and not to the upside at the moment.

These hyper turbulent moments are when you can be made to look very foolish – just look at my recent mistakes.  Because the “mood of the market” clearly is so volatile my advice is to sit tight until there is greater direction.  Ugh!

What’s important is to weigh the returns in cash (~ 1%) with the stock market (~ ?%) over the remainder of the year.

If it is any consolation I have remained fully invested throughout this period.  I am not in panic mode.  I recognize that these periods are often times of tremendous opportunity.  If you are fortunate enough to be in cash then stay in cash because any potential upside return missed on a rally is paltry compared to the potential downside.

If you are invested, ask yourself if the businesses that you own interests in are doing: not well, okay, or well.  If they are doing well then the professional managers of these firms are going to adapt to the economic landscape and quickly.  They will maintain and restore profitability at their firms post haste.

In answer to the query of the blog title, I am not scared of stock market falls.  What I am scared of is a U.S. economy that cannot seem to generate new jobs in large proportion and U.S. businesses that are sitting on $3 trillion of cash earning just 1% rather than investing in something that can earn more than 1%.  In other words, these are the trends to continue to watch.

Hope that helps!

Jason