The current topic of debate in the investment world is have we reached a bottom? Are the markets in consolidation mode? Certainly, some key data points suggest we might be at the bottom, but others suggest there still might be a shoe to drop, and, if this is the case, we might be headed toward another test of the March lows.
If you have been reading this column since last December, you know that I argued we had reached a bottom when the Dow Jones Industrial Average (DJIA) traded in the range of 8100-8800, give or take. I made that argument for a number of reasons, not the least of which was that the data points I watch suggested that the financial issues plaguing the economy were abating. For example, the 3-month LIBOR had dropped from its high of over 5% in October/November to around 1% or so. Here's what I said back then.
The DJIA picture hasn't changed much in the last two weeks. The highly watched market barometer is still trading in the 8100 - 8800 range, and the trading volume is still relatively low. This is more than interesting as the economic picture painted in the media is quite grim and seemingly headed for harder times. Unemployment is hitting record highs. Banks are frustratingly slow in lending out the money handed over to them through the TARP. The U.S. auto industry is on the verge of collapse. The global economy is rapidly following the U.S. into a deeper recession. The dollar seems to be in a free fall, having lost all of its recent gains against the Euro, and the housing market is still slumping with foreclosures happening at a record pace. So how is it that the market indexes haven't dropped through the floor? My answer is simple: Huge amounts of trading dollars are waiting on the sideline to see if this is the bottom. This, of course, begs the question: Is it?
As you know, the DJIA continued trading in the 8100-8800 range through the first week or so of January, and then we fell through the bottom, and we fell hard right on through to March 9. Since then, the steady climb back to the 8000 level in the DJIA has been uplifting, but, more importantly, educational.
Lesson 1
My optimistic perspective in December rested on my belief in the data points I use to gauge the economic outlook. I still believe in those data points, but I have since added a couple more for stronger confirmation. This was my first lesson: One cannot get enough confirmation about market movement. This is the concrete aspect of "prediction" in the investment world. Much like a scientific experiment, one cannot draw a conclusion until one has collected enough data to support the conclusion, and the more data that supports the conclusion, the stronger the conclusion.
Lesson 2
The second important lesson I learned (relearned actually), and it is a big one, is that the abstract side of the investment world, market psychology, has no empirical base. One cannot gather enough data to ascertain what will move the minds and emotions of investors. Often, appearances are deceiving and illusions dominate, so guessing, not calculating, is the basis upon which a conclusion is formed. My conclusion that we had reached a bottom derived more from my emotion (abstract) than statistical evidence (concrete).
I believed I understood the market psychology in December. I honestly based my optimism on the idea that we had reached capitulation, investors were done with mass selling. That idea is reflected in the black and bold sentence in the above quote. I truly believed investors were simply in stasis after the long fall in October and November. I believed investors were no longer interested in selling off. I believed they, too, were just waiting and looking for more confirmation of a bottom. The red and bold sentence in the above quote reflects this, but underneath the surface of this seeming wisdom lay a bit of denial: If investors could not confirm a bottom, they could sell off again. I didn't want to see that, so I didn't.
As it turned out, that was a mistake. The market selloff that started on January 9 and continued right through March 9 only abated when both the concrete and the abstract merged. Citigroup, Bank of America, Wells Fargo, and JP Morgan announced operational profits for January and February. Fed Chairman Ben Bernanke announced the Fed would take whatever actions were necessary to keep the economy running. GM declined $2 billion of bailout money for March and Treasury Secretary Tim Geithner seemed more confident testifying in front of Congress. As well, Larry Summers, the leading economic adviser to President Obama started speaking, and both he and the President adopted a more openly sympathetic position toward the business community. The administration started speaking confidently with one voice. And consumer confidence rose slightly in January and February.
This led to a quick upsurge and the beginning of the rally we see today. The DJIA rose from the low of 6547 back up to 7223 in four days.
This rally continues today, which brings us back to the question: Is this the bottom? Unfortunately, the concrete is not separate from abstract in the investment world, so an answer, even one based on statistical evidence, is sketchy, as there might well be another shoe out there to drop. Maybe it is the credit card companies and the rising default rate there (concrete), or maybe it is the way Larry Summers combs his hair (or doesn't) on a certain day (abstract). At this point, it could easily go either way.
If you have been reading this column since last December, you know that I argued we had reached a bottom when the Dow Jones Industrial Average (DJIA) traded in the range of 8100-8800, give or take. I made that argument for a number of reasons, not the least of which was that the data points I watch suggested that the financial issues plaguing the economy were abating. For example, the 3-month LIBOR had dropped from its high of over 5% in October/November to around 1% or so. Here's what I said back then.
The DJIA picture hasn't changed much in the last two weeks. The highly watched market barometer is still trading in the 8100 - 8800 range, and the trading volume is still relatively low. This is more than interesting as the economic picture painted in the media is quite grim and seemingly headed for harder times. Unemployment is hitting record highs. Banks are frustratingly slow in lending out the money handed over to them through the TARP. The U.S. auto industry is on the verge of collapse. The global economy is rapidly following the U.S. into a deeper recession. The dollar seems to be in a free fall, having lost all of its recent gains against the Euro, and the housing market is still slumping with foreclosures happening at a record pace. So how is it that the market indexes haven't dropped through the floor? My answer is simple: Huge amounts of trading dollars are waiting on the sideline to see if this is the bottom. This, of course, begs the question: Is it?
As you know, the DJIA continued trading in the 8100-8800 range through the first week or so of January, and then we fell through the bottom, and we fell hard right on through to March 9. Since then, the steady climb back to the 8000 level in the DJIA has been uplifting, but, more importantly, educational.
Lesson 1
My optimistic perspective in December rested on my belief in the data points I use to gauge the economic outlook. I still believe in those data points, but I have since added a couple more for stronger confirmation. This was my first lesson: One cannot get enough confirmation about market movement. This is the concrete aspect of "prediction" in the investment world. Much like a scientific experiment, one cannot draw a conclusion until one has collected enough data to support the conclusion, and the more data that supports the conclusion, the stronger the conclusion.
Lesson 2
The second important lesson I learned (relearned actually), and it is a big one, is that the abstract side of the investment world, market psychology, has no empirical base. One cannot gather enough data to ascertain what will move the minds and emotions of investors. Often, appearances are deceiving and illusions dominate, so guessing, not calculating, is the basis upon which a conclusion is formed. My conclusion that we had reached a bottom derived more from my emotion (abstract) than statistical evidence (concrete).
I believed I understood the market psychology in December. I honestly based my optimism on the idea that we had reached capitulation, investors were done with mass selling. That idea is reflected in the black and bold sentence in the above quote. I truly believed investors were simply in stasis after the long fall in October and November. I believed investors were no longer interested in selling off. I believed they, too, were just waiting and looking for more confirmation of a bottom. The red and bold sentence in the above quote reflects this, but underneath the surface of this seeming wisdom lay a bit of denial: If investors could not confirm a bottom, they could sell off again. I didn't want to see that, so I didn't.
As it turned out, that was a mistake. The market selloff that started on January 9 and continued right through March 9 only abated when both the concrete and the abstract merged. Citigroup, Bank of America, Wells Fargo, and JP Morgan announced operational profits for January and February. Fed Chairman Ben Bernanke announced the Fed would take whatever actions were necessary to keep the economy running. GM declined $2 billion of bailout money for March and Treasury Secretary Tim Geithner seemed more confident testifying in front of Congress. As well, Larry Summers, the leading economic adviser to President Obama started speaking, and both he and the President adopted a more openly sympathetic position toward the business community. The administration started speaking confidently with one voice. And consumer confidence rose slightly in January and February.
This led to a quick upsurge and the beginning of the rally we see today. The DJIA rose from the low of 6547 back up to 7223 in four days.
This rally continues today, which brings us back to the question: Is this the bottom? Unfortunately, the concrete is not separate from abstract in the investment world, so an answer, even one based on statistical evidence, is sketchy, as there might well be another shoe out there to drop. Maybe it is the credit card companies and the rising default rate there (concrete), or maybe it is the way Larry Summers combs his hair (or doesn't) on a certain day (abstract). At this point, it could easily go either way.
