The Good, The Bad & The Missing
The market is constantly weighing three inputs to determine its direction and risk profile: what it views as positive, what it views as negative, and what it does not yet understand. I like to call this the Good, the Bad, and the Missing. While no one can argue that the Bad has been the most influential of the three inputs as of late, I want to share with you a few thoughts concerning the dynamics of these three factors and how the market values and weighs them.
Contrary to what seems logical, the market does not need to have more "good" than "bad" to reverse a downturn and move to an advancing posture. In fact, given that the market is a forward looking machine, it does not wait to completely emerge from the dark before it starts to improve, but rather, it just needs to view the light at the end of the tunnel. Examining every recession and bear market since WWII reveals that stocks have always bottomed before the recession was over and delivered, on average, returns with a powerful 25% upside potential, as measured by the S&P 500 Index, and furthermore, recouped nearly all losses by the end of the recession.
So, the question remains, when will the market find the balance between good and bad that will propel it to shift from fear to opportunity? It is my opinion that this transition is upon us now. While this may contradict the many negative headlines reported by the media, the fact remains that the velocity of the good things happening in the market is increasing, while the velocity of the bad is slowing. The inflection point as to when the market improves surrounds the timing of when the bad stops getting worse and the good starts to gain frequency.
As far as the Good, we are starting to see it trickle in a bit faster than it did just a few months ago. The stimulus package and foreclosure relief were approved and we have gotten some encouraging news on retail sales, wages, and inflation data as of late. In addition, volatility has eased and liquidity in the credit markets has improved. While the Bad is too numerous to list, the velocity of negative news from the housing front and unemployment has begun to slow.
By now, you may be asking yourself, if the equilibrium between the Good and the Bad has indeed turned to a more positive (or at least less negative) balance, then why haven't the markets improved? It is because of the third factor: the Missing. There is currently a clarity void overhanging this market, which has been the primary catalyst for stocks retreating back below their November 20, 2008 market lows. The remaining unanswered questions largely surround the details of the government's many stimulus and rescue packages as well as the future state of the financial services industry. Do the banks need further capitalization? Will the banks be nationalized? What is the plan to remove the toxic assets off bank balance sheets?
It is my opinion that answers to the market's lingering questions are forthcoming. The Obama administration knows that the market is waiting for details and in my opinion has learned that the "trust me", high-level descriptions of its plans to improve the financial markets through fiscal and monetary policy are not enough clarity for the market to be comfortable. We are in a "show me" market that wants details. Once these missing details are uncovered, the market can once again refocus its attention to the increasing pace of good news and the declining pace of bad news, with the likely result of the market establishing the basis for a bottom.
This is not to say that the market and this economy do not have tough bridges yet to cross. But as the Good gets better, the Bad diminishes, and the Missing gets answered, it is my view that the backdrop for market improvement will be established. These retesting challenges and subsequent small victories are what make a market bottom. I continue to believe that long-term investors will be rewarded by patience and that new assets will benefit from careful entry into the market at these attractive levels.
You may have questions regarding the Bad that remains in this market and as always, I encourage you to contact me. The sun is brightest after a storm and with a few answers to the Missing, soon we just may start to see the Good once again.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Stock investing involves risk including loss of principal.
This research material has been prepared by LPL Financial.
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