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Sept 1, 2009

“What the Wise Man Does at the Beginning, Fools Do in the End”
--Warren Buffet

THE MARKETS

Even though the 4th of July was about two months ago, we may see some fireworks in the financial markets over the next few months.

Since Independence Day, trading volume has been rather low and volatility somewhat subdued. Traditionally, the movers and shakers on Wall Street retreat to the Hamptons and other far-flung places around the world during the summer and, as a result, we often see little action during the warm months. This summer was no exception as big drops have been rare. Instead, we’ve seen a steady, non-volatile rise in the major averages. We are now into the last week of this summer hiatus and, as the titans of finance return and Congress gets set to start legislating again, the sparks may fly.

Like fireworks, these sparks could do one of two things. First, they could make us “ooh and aah” over how beautiful they are, i.e., we get a big market rally. Or, second, we could get too close and get burned, i.e., the market tanks. Some would also argue that there’s a third possibility – we could just muddle about and stay in an extended trading range. This might be analogous to a firework that misfires and fizzles out.

As much as we would like to dust off our crystal ball and peer into it for prescience, we know that predicting the future is not an effective investment strategy. However, thinking about possible scenarios, developing plans and being ready to adjust course as situations unfold is appropriate.

We don’t know which type of sparks might fly in the next few months, or even if sparks will fly, but, if they do, we will do our best to help you enjoy and profit from them.

CHART OF THE MONTH

For some perspective on the current stock market rally and how it compares the 1929-1932 bear market (which also included bank failures, bankruptcies, severe stock market declines, etc.), today's chart illustrates the duration (calendar days) and magnitude (percent gain) of all significant Dow rallies that occurred during the 1929-1932 bear market (solid blue dots). For example, the bear market rally that began in November 1929 lasted 155 calendar days and resulted in a gain of 48%. As today's chart illustrates, the duration of the current Dow rally (hollow blue dot labeled you are here) is longer than any that occurred during the 1929-1932 bear market. As for magnitude, only the November 1929 bear market rally resulted in a better performance than what has occurred during the current rally to date.

HERE’S A TRIVIA QUESTION FOR YOU: How many bull markets has the United States experienced since 1927? We define a bull market as a rally of at least 20% that was preceded by a decline of at least 20%.

The answer is 26, according to Bespoke Investment Group. Interestingly, 10 of those bull markets occurred during the decade of the 1930s. Overall, the stock market was horrible during the 1930s as the S&P 500 index had a total return of 0.0% for that depressing 10-year stretch, according to Vanguard. Doesn’t it seem a bit odd that a decade could have 10 bull markets yet still end the period with absolutely zero return?

The reason for this oddity is that some of the best bull markets happen within the context of a long secular bear market. These “snapback” rallies may be powerful and alluring. They may lull unsuspecting investors into thinking that all is well. But, just when the majority is breathing a sigh of relief, the market may do what it does best – drop anew and confuse all but the sharpest investors.

Could the current rally simply be one of those snapback rallies that ensnare unsuspecting investors?

Bears point out that between the September 1929 bull market high and the mid-1932 bear market low, there were four bull markets – one of which was a 46% rally that lasted 148 days. Yet, during that nearly three-year period, the stock market still lost more than 80% of its value. The bears say the current rally is a snapback rally that will give way to further declines down the road.

Bulls, by contrast, say the current rally, which has driven the S&P 500 up 52% since its March 9 low, is so strong that it heralds a new bull market as opposed to just being a bear market rally. Supporting their claim is recent data that suggests the economy is finally starting to stabilize.

So, who’s right? The bulls or the bears?

Ironically, they both could be right. By definition, we’re clearly in a bull market. However, that does not preclude another drop of 20%, which would signal a new bear market. This 20% drop could happen in the next 90 days or it might not happen for two or three years. Like all investors, we have no way of knowing with precision when the next 20% drop will happen. Instead, we take the news as it happens and do our best to adjust accordingly to help meet your goals and objectives.

INVESTORS ARE DRIVEN BY THE FEAR OF LOSING AND THE FEAR OF LOSING OUT. Last winter, as the financial markets were seemingly in a free fall, panic and fear reigned. There was a sense that the worldwide financial system could collapse and that the problem was bigger than the government’s ability to solve it. This fear of losing spurred more selling and it became a vicious cycle – until it stopped. Today, it’s a completely different picture.

Today, the banking system is back from the brink. Liquidity is improving. The S&P 500 index is up about 50% from its March low. And, the economy is showing signs of coming back to life. Ironically, fear is also returning to the markets. However, it is not the fear of losing money; rather, it is the fear of losing out from making a big killing as the markets recover.

Both types of fear have the ability to dramatically move the markets.

To state the obvious, humans are emotional. For example, we’re emotional about relationships, about work, about politics, about religion, about food, and, of course, about money. As humans oscillate between the fear of losing money and the fear of missing out on making it, we tend to drive the financial markets much lower and much higher than “reason” might dictate.

The tricky question facing investors right now is, “Will the fear of missing out on a big rally drive this market even higher as investors who have been on the sideline decide they have to get in?” Back in the late 1990s, the technology-led stock market bubble took stock prices to an unprecedented level that was far higher than justified by “fundamentals.” Could history be repeating itself?

Interestingly, as of last Friday, the S&P 500 index was 22% lower than it was 10 years ago. For the bulls, this suggests the market still has lots of room to run higher and is in no danger of being in bubble territory. For the bears, they point to a near 50% rise and say it’s time for a breather. Also, famed investors such as Paul Tudor Jones think this is nothing more than a sharp bear market rally.

Ultimately, significant money can be made or lost during periods when human emotions move toward the extremes of “fear of losing” and “fear of losing out.” We work diligently on your behalf to try to be on the profitable side of the “fear” investment.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” -Warren Buffett

Thanks for your trust & confidence,

ken@fordwealth.com | 201-798-7992

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.
* The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
* The Nasdaq Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.
* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
* Consult your financial professional before making any investment decision.
* You cannot invest directly in an index.
* Past performance does not guarantee future results.