Something Wicked This Way Comes
October 7, 2011
The Force of Fear
The stock market decline in the third quarter of this year (July-September), are a proof of the force of fear. Even as corporations report increased earnings and the GDP is revised upward, the market has continued to act as if the end of the world was at hand. The Dow Jones Industrial Average fell about 12% for the three months. The S&P 500 Stock Index fell about 14% for the same period.
Last week, the stock market seesawed up and down as much as four or five percent per day. The Reuters News Service headlines at the end of each market day were quite revealing as to why. Two of those headlines (the bolding is mine):
- Stocks Drop, led by Commodities on Economic Fear
- Stocks rally on Europe Debt Optimism
Traders are vacillating between Fear and Optimism. I want you to consider that neither of those is real. They are feelings. In the end, the values of things we own do not depend on our emotions, but on the hard-nosed reality of economic principles.
Even the fear itself is not at all well defined. The number one “wicked” something that people seem to fear is the default of Greece. I have written this before and I will probably get to write it again. Greece is going to default. The numbers are very clear. Greece absolutely cannot afford to pay its debts.
The fear appears to be that if (when) Greece defaults, European banks and nations will become insolvent because they have large holdings of Greek bonds. Investors seem to fear that the chain of defaults that follows will be more severe than that following the Lehman Brothers default back in 2008-2009. Greece is not Lehman Brothers. With Lehman, there was a massive worldwide unpreparedness. There is ample evidence that preparations are being made in every institution and nation across Europe and the United States.
The second “wicked” thing we seem to fear is that something terrible is about to happen here in the United States. Among those who express that fear, the consensus seems to be that it will come because of the nefarious activities of the President. Beyond that, I have been unable to nail down any specific terrible event that they fear.
When John Kennedy was President, I listened as conservatives insisted that the Pope would set himself up as the ruler of America (Kennedy was our first Roman Catholic President). I again listened as very intense, left-leaning college students insisted that Richard Nixon was going to stage a coup and become dictator. While Jimmy Carter was President, conservative friends of mine insisted that the Trilateral Commission was a front for the “one world government” that would take over and enslave us all. During George W. Bush’s presidency, the conspiracy theory (from the left) was that Halliburton was secretly running the government and the wars in Iraq and Afghanistan were solely for Halliburton’s profit.
In this age of 24 hour news channels, cell-phones, and mass email forwarding, conspiracy theories and urban myths can easily “go viral” and be widely believed. That does not make them more real or less damaging.
The Wicked “Something”
I have taken the title of this letter not from its origin in Shakespeare’s Macbeth, but from Ray Bradbury’s novel by that name. In Bradbury’s novel, fear gradually settles over a small town as a carnival arrives late in the year. It opens with a lightning-rod salesman warning that, “A storm is coming.” The scene is set quite literally in the “fall” of the year. The carnival is indeed an evil mechanism that exists to imprison the carefree souls of young boys. Very critically, fear is the only weapon Mr. Dark, the master of the carnival, has at his disposal. Laughter, dancing, and singing free the children’s souls and the loving embrace of a father destroys the power of the carnival master.
The “something wicked” that comes in the novel is fear. Securities markets tend to be moved in the short-term by the twin emotions of fear and greed. The highest levels of volatility in the market come near the top and the bottom of market cycles as the adherents of those two emotions battle it out. If in the relatively recent past the optimists have been the dominant force, then market values are likely to reverse course and decline substantially. If in the past couple of years there has been a great deal of pessimism and fear, then it will not be long before the market starts back up. These reversals can take months, and sometimes many months, but the end of the high fluctuations is almost always a mark of the reversal of sentiment.
Right now, it is clear that as a whole, those corporations listed on the exchanges are doing quite well. That is where we invest. We do not invest in the unemployment rate or the GDP. Those are indicators, and they are important indicators, but even in times when unemployment is high and the GDP is in bad shape, there will be companies that are turning a nice profit. As an example, the employment reports consistently reveal that companies are hiring and the government is laying-off workers. The net result is high unemployment, but it is mostly in local and state governments where that is occurring. Fortunately, our investments are not in governments!
The Thing That is Really Coming
At some point, the greed factor will overcome the fear factor in the markets. If history is any guide, that will happen sometime between now and the end of this year. I only say that because it is such a consistent pattern in history. If we analyze the data again at the end of the year we may find that nothing has actually changed. What will likely make the market indices rise is simply a reversal of sentiment.
When there is a legitimate reason for concern evident in the underlying economy, the pattern we commonly see is gains in the summer followed by a decline beginning in October. When the underlying economic reality is solidly profitable, but baseless emotion forces the market values down, then we typically see losses in the summer and a reversal to the upside in late October. The stock market peaked in October, of 2000 and again in 2007. In retrospect, during the summers we now can see as the ends of the bull markets, values rose in spite of bad economic data. During the summers at the end of bear markets, market values tended to fall despite improving economic data. “It’s Déjà vu all over again.” *
My reading is that the car and truck count on I-35 is growing. The parking lots at the outlet malls are full. Here in Salado, we just had what appears to be a record-shopping weekend. If that pattern holds, then things are getting better and the stock market will respond. It is not so much a matter of “if” as “when.”
As always, if you have any questions or comments we are available.
Sincerely yours,
Jeffrey W. McClure, CFP®
*Quote from that wise sage of New York, Yogi Berra.