One day it’s fear and loathing, the next it’s hope springs eternal. We live these days with the stock market acting as a manic depressive. That’s nothing new,of course, as Warren Buffett has long characterized the equity market is such colorful terms. But lately it seems even more so, a fact made painfully clear by the rising VIX and by the rapidly changing value of your portfolio. Thursday it was up, way up, with the Dow rising 275 points.
What seems to have the market in such a volatile mood is uncertainty–today we swung to optimism–about the next 12 months, as the world grapples with more than a trillion dollars in global stimulus and a mountain of troubled debts. But just when things seem to be getting too dark, a day like Thursday comes along when the economic news improves. In this case it was a drop in jobless claims, word that China’s oil imports are growing and a bit of optimism from the European Central Bank, which bumped up its growth forecast for 2010.
So if things are improving, is it time to be loading up on depressed stocks? I interviewed Joseph Quinlan, the chief strategist for wealth manager U.S. Trust earlier this week, and he believes the market’s direction for the second half of 2010 is up, maybe another 15% from here, as frightened investors slowly return to stocks, encouraged by an improving economy. But I also respect the analysis of David Rosenberg, the bearish chief economist and strategist at Gluskin Scheff in Toronto. Here’s the advice he’s giving his clients:
“As we said, use interim bounces, when they occur, as an opportunity to purge risk and cyclicality from the portfolio and move up the quality chain. The charts don’t lie and the trend lines in the major stock market averages have peaked out or rolled over.”
Rosenberg doesn’t believe that the private sector is taking over from the public spending stimulus in terms of spending, and there are abundant stats to back him up. The fascinating twist in all of this analysis, though, is that both bulls and bears may be right. We have an economic recovery that it is still too dependent on federal stimulus, including super cheap credit. The economy may weaken as the stimulus effects fade, and investors may take stocks lower as that weakness is revealed. But in times like these the wise investor takes neither the bullish road nor the bearish, but blazes a path up the middle, reducing risk but staying in the game.
The reason for such a middle road is something called reflexivity, a term I attribute to George Soros, who explained it in his book, The Alchemy of Finance. The complex idea has a simple version, which basically says that people are thinking players, or participants, and their thinking affects the situation that they are observing. Applied to the current situation one might say that if the bearish case–i.e., a double dip–really begins to unfold, it won’t unfold in a vacuum–and some famous thinking participants might start preparing a second stimulus package. At the same time, in the face of renewed economic weakness opponents to a second stimulus may lower their voice. Conversely, if the economy takes off from here, the Fed and the credit markets will be observing and probably responding. Sometimes reflexivity can perpetuate a trend, but in this case I think it’s more likely to reverse one. The bottom line, here, may simply be not to bet too big on either extreme outcome, no matter what signal the market sends on any day.
Finally, my apologies to Soros if my simple explanation has done injustice to his idea.