Interpreting Market Worries: The Year in Review
When looking ahead, it is often helpful to know where you have been. The calendar provides an arbitrary dividing line. It is better to do a constant process of re-evaluation and review. Since most people need a nudge, we all take a special look at the start of a new year.
As I work on my forecast, I have already reached two important conclusions about 2010:
- Many of the market worries were resolved — some quite decisively — as the year progressed.
- The overall level of concern was undiminished.
This is quite remarkable.
The single most important thing for the investor to understand — right now — is the value of worries. If you are looking for good investment returns, you need a time when others are worried.
The concept of the "wall of worry" is difficult for the average investor. They seem to think it is bad when there are many worries. In fact, the lack of worry is a sign of a market top. Let me simplify.
Here is the image of the market top: "What? Me Worry?"
When there are plenty of things to worry about, we are not yet at a market top. If all of the worries were resolved we would be at Dow 20K. (At the end of May, with the Dow at 10K, I wrote that it would double rather than getting cut in half, despite all of the doomsday predictions. We are now 15% of the way there.)
The Worries of 2010
I am working on an article that will review the "Worries of 2010." My starting idea for classification includes the following:
- Valid concerns that are still with us;
- Valid concerns that declined during the year;
- Concerns that were mostly political — better ignored by investors;
- Totally bogus concerns that got a lot of publicity.
I am open to the suggestion of new categories.
Here is a list of worries that I have noted, in no particular order:
- ETF liquidation doomsday scenario
- Flash crash — and overall worries about market manipulation
- Bush-era tax cut expiration
- Collapse of the euro and/or European Union
- The Hindenburg Omen
- Increase in US budget deficits
- Ominous head-and-shoulders pattern in market averages
- Dow 5000
- Dow 2000
- Dow 1000
- The collapse of the US consumer
- The double-dip recession
- Sell in May
- Sell in October
- Sell, Mortimer, Sell (OK, I sneaked that one in for those who know).
- The BP spill
- Fear of Obama
- Weakness in the dollar
- Strength in the dollar
- Weakness in China's economy
- Strength in China, leading to higher rates
- Initial claims spiking to over 500K
- Initial claims falling, but results skewed by seasonality
- Shadow housing inventory
- Foreclosure robo signing
- Overstated and exaggerated corporate earnings
- Fed blunders — QE II
- High frequency trading
- Worldwide collapse and deflation
- Worldwide hyperinflation
Please help me in adding to this list. Comments very welcome.
Help in getting started
Some of the worries have proven to be either false or dramatically overstated. Without arguing about the data, let us just look at the Google Trend on "double dip recession." While a recession is always possible through an expected shock, anyone making this as his base case scenario has lost touch with the data. Google Trends is a nice "wisdom of crowds" sort of indicator.
Here is another good case, the big scare about the Hindenburg Omen.
This was another case where many people were scared out of their investments because of a contrived indicator that I exposed in August, near the peak of the bogus fear. (The Dow closed at 9985 that day.)
My working conclusion is that many worries have been resolved, but new ones are created at an equal pace. As long as there is so much to fear, we are not close to a market top.
I am going to follow up on this, but I hope to stimulate comments and suggestions as part of my framework.
A Word about Risk
Worries imply risk. Each investor is different. During 2010 I have frequently cited the need for each investor to analyze his own needs and risk tolerance. Too many investors missed out on 2010 because of a feeling that they needed to guess the market — all in or all out. This is weak. An investment program is a carefully designed mixture of approaches.
Investors need to understand whether they are protecting assests, or growing assets. Wealth preservation or wealth creation. Then they need to analyze risk.
Investors spend too much time thinking about the market, and too little time thinking about their own needs.