Mid-Year Market Review: Bull or Bear Arguments. What to do now?

“I don’t know what to do! I personally feel bearish. But then I see markets go up though 3% in two days! So the bulls must be back. Right? Buy, sell, buy, sell … I’m going to go broke if I keep this up!”

Silly investor, thought he was smarter than the most powerful secular force on the planet. You unfortunately can’t time this stuff. Investment means risk for potential reward; it does not mean risk automatically equals reward.

So after about 14 months of an unprecedented run-up in stock prices (similar in precedence to the drop in 2008 and 2009), market volatility has returned. Most folks — including academics, economists, and investment managers — did not expect from Q2 2009 to Q1 2010 to play out as remarkably positive as it did. As with all major market moves, when the world thinks one thing, the opposite, and often unexpected, happens. Markets peaked about two months ago (April 23) and are off about 10% to 25% since then depending on what world markets you look at (i.e. U.S., International, Emerging Markets).

How in the world could anyone have been fully right out of the market ahead of 2008 and then fully right in the market ahead of 2009? I have not heard of anyone being right twice on that one. Those who stuck to a good plan did okay, though. I’ve met a lot of those folks.

But fear is back in the air…. There’s a huge volume of arguments (many very compelling and persuasive) for and against prospective Bear and Bull Markets. For long-term investors, much of this should be noise, although the world has made it easy for noise to influence decision making.

Below are examples of commentary out there that could inspire bad behavior.

First, some of the Bears .

  • Bear: Global economies have a low probability of a double-dip recession. This thought is widely against the grain of major media outlets and economist alike, but the recent economic data of this past two weeks points to that view — specifically historically weak housing and employment data along with other leading indicators. Furthermore, stock markets almost always lead economic reports and equity markets are behaving as if the economy is not on the upswing. Again, a low probability event of which hopefully doesn’t occur.
  • Bear: If that’s not the case, though, the general consensus globally is that the U.S. Government and other debtor nations cannot sustain the level of unprecedented spending level much longer without putting the U.S. and global economies into a long and painful contraction.
  • Bear: The state and local governments, along with public pension plans are universally running large deficits. Budget and benefit cuts are inevitable across the country. Tax increases will depend on the state.
  • Bear: The issue-du-jour as I write is not whether the U.S. economy is headed for inflation, but rather deflation … it is amazing how the tide of opinion and economic data can rapidly change in just six months.
  • Bear: The U.S. economy may not be able to handle another shock to the system. In previous shocks (1982, 1995, 2008 etc), the economy got through it because the Federal Reserve had the ability to cut rates and stimulate the economy. Today there is very little, if any, room to cut rates again. The Fed rate is 0% to 0.25%, how do you cut 0%?

Okay, now we hear from some of the Bulls.

  • Bull: Mortgage rates are at historical lows and refinancing activity is up over 150% in the past year. This is putting cash in people’s pockets.
  • Bull: Energy prices are stable, if not falling. This too is putting cash in people’s pockets.
  • Bull: Overseas, fortunately, many countries are taking (or at least stating they are) a very strong position on their debt problems. Many of them are looking to get control of their debt and deficits with actions being taken now (namely Germany, China, among others). Other countries like Canada, Australia, Switzerland, and a few others have nowhere near the deficit problems the U.S. faces.
  • Bull: The U.S. is still the reserve currency and the strongest economy in the world. This is why we keep hearing about “flights to quality” in regards to the EuroZone problems: Global investors currently seek out our debt as the safest.
  • Bull: Corporate balance sheets around the globe (i.e. stocks) have been shored up significantly in the past year and so debt levels at the corporate level are nowhere near the levels they were two years ago.
  • Bull: Corporate earnings are also strong of late, while the price-to-earnings ratio (a measurement of relative value) on stocks year-over-year are at relatively low levels. (This is debatable.)
  • Bull: The amount of bear-opinions v. bull-opinions is quite diverse. This sounds odd that this would be a positive, but remember when everyone is on one side of the trade or shares the same market opinion (think March 2000 or August 2008 or March 2009), they tend to be wrong or at a minimum, too late to correct. When opinion is diverse, markets tend to have more balance.

I can continue this list of Bull versus Bear arguments. This becomes not only paralysis-by-analysis, but also quite boring. I don’t know what a list like that would do to help us either, since if you are reading this and thinking about it, then I guarantee this list is already widely known by the markets, priced into valuations, and is hardly something we can exploit.

So what do we do?

Well, we can continue to behave erratically with our money and go in and out and out and in and react to every talking head comment until we literally are broke … or we can start with the question: am I an investor or a saver (preferably both)? If I’m a saver, I stick with cash equivalents. Inflation becomes my enemy long-term, though, but at least I have what I need in the short term.

If I’m an investor, perhaps there is some mix of stocks and bonds (and maybe some real estate, alternatives, etc.) I can pursue. Volatility is my enemy though and so I need to know what level of risk can I handle. Stocks and other volatile assets by themselves can fall over 50% in a given time frame. Can I handle this? If not, then dial out the stock risk with stable investments like short-term high-grade bonds, to the point the risk balance is in line what I can handle.

We give up potential return, but so what? You limit risk and then choose to save more, spend less, and maybe work longer … perhaps not ideal, but those are relatively controllable strategies and far easier to do than trying to time or control the market.

Then we live with the results, thinking long-term, managing to the strategy that point forth on a regular basis, making shifts when our goals or capacity for risk changes … the cycle continues, but it does so pragmatically and with discipline. Some decisions might not work, but they will also likely not be irreversibly damaging either.

At the end of the day, the world can be crazy and erratic, but your financial planning doesn’t need to be. Sound thinking in advance can help you be less wrong than others which is a pretty good place to be where the only certainty seems to be uncertainty.

Michael Dubis is a fee-only Certified Financial Planner and President of Michael A. Dubis Financial Planning, LLC. He is also an adjunct lecturer at the University of Wisconsin Business School James A. Graaskamp Center for Real Estate. Mike can be reached at financialperspectives@gmail.com.

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