After two months of range-bound trading, investors punched through resistance and bid the markets to new yearly highs this week. The Dow, NASDAQ and the S&P all look like they want to go higher but may need a bit of a pause here to catch its breath.
As I expected, second quarter earnings were the trigger that ignited markets to the upside. Last week’s positive earnings reports were followed this week by more of the same. Many companies beat expectations and indicated that their businesses were either improving or at least not getting any worse. That was all investors needed.
Sure, there were companies that had downside earnings surprises or saw no improvement in their business but they were in the minority. The bears, meanwhile, are crying foul. They argue that most of the improvements in company earnings were based on cost-cutting and not in improvement of core businesses. Economists note that there is no conclusive evidence thus far that the economy has turned the corner while unemployment appears to be heading for 10%.
“Who ever heard of a recovery taking place with 10% unemployment,” scoffed one client over lunch in Williamstown last weekend.
To drive her point home, she pointed out that the restaurant we sat in had only two occupied tables.
“You couldn’t get in here for lunch three years ago,” she said.
I explained to her that throughout history it was not unusual for unemployment to remain high or even rise further while the economy began its recovery. During the Great Depression, for example, the country experienced double digit unemployment in 1938 while the economy began its recovery. It was only in 1940 that unemployment dropped dramatically and some of that decline was due to the country’s preparation for war.
“But the economic numbers are contradictory,” protested her husband. “One week they look good, the next terrible.”
“That’s to be expected,” I argued.
“Well, why not wait until we have proof. Then we’ll begin to invest,” she said.
“If you wait until you spot the first robin, you will miss most of the spring.”
As I’ve said before, an economic recovery is a process not an event and it’s important to remember that the stock markets anticipate recovery many months ahead of the numbers.
I also understand that last year’s market declines were a devastating blow to investor confidence not only with the stock market but with the financial system overall. We don’t trust the markets or its participants. Although I think a healthy dose of skepticism is appropriate, it should not deter you from re-investing or trying to recoup some of the money you lost last year.
I continue to remark on how little volume has accompanied this rally. In my opinion, the individual investor has practically deserted the stock markets. Those who have dared to venture back into these waters have done so with at most one toe or two. I understand that fear but unfortunately, people’s risk tolerance for additional losses is very low at a time when the potential rewards of investing are extremely high.
Now that does not mean we are in a new up, up and away bull market. I expect we will continue to move higher but not without some steep pullbacks on the order of 10-15 or even 20%. Think of the market’s direction as a flight of stairs. We’ve moved up 38% from the March lows. That’s one big step. We then spent two months in a fairly tight trading range (standing on the flat part of that first step) and now we are preparing to move up to the next step.
But be aware that there could quite possibly be a sudden and steep decline awaiting us sometime in the fall. I’ll call that a missing step, dangerous but manageable.
The point is that it will be difficult for the individual investor to climb up this staircase alone. The days when an investor could practically throw a dart at the stock listings and make money are over for the foreseeable future. To manage your money alone, you will need to devote more time and effort to researching and following your investments. You will also need to accept the stress that comes with volatile markets and potential losses. Don’t make the mistake of thinking you will be able to do this as a part-time hobby. If you are already retired you may have the time but it still won’t be easy. Welcome to the new world of investing