The stock market caught everybody off-guard on Friday August 3rd; the S&P 500 index climbed 1.90% on news that the U.S. economy created 163,000 new jobs in July–about 60% more than economists were expecting. Or maybe it was attributed to excitement over the Grand Opening of our new offices in Bellevue, Kentucky. Somehow I doubt this was the case, but it was an event and if you missed it, be sure to check out our Facebook page for some excellent pictures of the event and the space. More importantly, this was the fourth consecutive week of gains (make that 5 weeks to date), and there is no clear explanation for those other positive trading weeks in the economic numbers.
Newspaper columnists and cable pundits have told us that investors were expecting the Federal Reserve Board to do something to stimulate the economy. But what, exactly, can the Fed do now that interest rates are at rock bottom? Buy more Treasury bonds when rates are already near the lowest in the world? Lend to banks at even cheaper rates than they do now?
Others have said that investors are feeling optimistic that the Eurozone debt crisis is easing. Spain’s potential full-fledged bailout reassured investors who had been worried that the Spanish government would resist asking for help even as its two-year government bond rates topped 7%.
So where did this (admittedly guarded) optimism come from? The interesting thing here is that inexplicable rises in the stock market are not uncommon, and many times they are one of the first indications of a yet-unseen recovery in the economy. Economists divide the numbers they watch into two categories: “leading” and “trailing” indicators. The leading indicators hint at the future; that is, they change before the economy as a whole changes. Trailing indicators confirm the trend.
The Conference Board lists ten leading indicators–and one of them happens to be the Standard & Poor’s stock index. It seems to work–although not perfectly–in predicting when the U.S. will fall into, or pull out, of a recession or experience better economic growth. Markets have tended to drop before the recession hits, and they tend to start recovering before the U.S. has emerged from the gray zone.
How does this work? The best explanation seems to be that our economy’s insiders–that is, corporate CEOs and top executives–are able to look at their own operations and notice improvements in sales, revenues or efficiency that economists cannot yet measure. Astute investors who have a network of friends and other sources deep in the economic system will get the same information, and both groups will start quietly buying into the market at what they regard as bargain prices. The market will start to go up without any apparent reason to outsiders – until the recovery is finally confirmed by those trailing economic indicators, at which point everybody else crowds in and we experience a bull market.
Of course, it works the other way as well. Toward the end of the bull, those same insiders sense that the current prices are too high for what they see in their own operations. They start to lighten up their stock holdings, shifting more weight to the sell side of the ledger, and stock prices inexplicably start trending downward.
This is why investors have found it historically difficult to time markets. The portfolios we manage have suffered some in the last 12–18 months due to our continued (abet cautious) exposure to international developed and emerging markets. We recognized these areas a well priced and ripe for opportunity. Just because a company is domiciled in Europe, doesn’t mean that its business growth is coming from Europe. The geography has been punishing, but long-term price appreciation is based on company fundamentals, not location.
Consider this smaller example; the Cincinnati riots of 2001. Did investors run and sell off investments in Kroger and Proctor and Gamble? Of course not! Local issues were not to derail such large companies doing business across the country and the world.
This is why market timing can be a hard row to hoe. Attempting to time a specific sector or company based on earnings or new product announcements might work in some instances, but trying to time a continent or global markets in general seldom produces successful results. Missing the best 10 days of the last 30 years would have literally reduced your returns to a fraction of otherwise staying the course.
Most of all, you should have the planning done to back up the reasons for your portfolio selection. I recently reviewed a hypothetical portfolio that a client brought to me. They said, “Look at how much better its doing and how much less risk!” Further analysis showed that their current portfolio had still performed better long-term and had 60% more upside potential based on the last 10 years of market returns. Most importantly, their Prosperity Plan (call me to learn more) was successful with their current portfolio, but not at all successful with the hypothetical. When taking a part-time job and cutting spending were discussed, they reaffirmed why they were invested the way they are and staying the course made sense.
In conclusion, cast aside the horror stories heard on cable TV, do your part to be financially responsible, and have some optimism. Optimism breeds confidence and confidence drives markets and portfolio values higher. Most of all, stay the course with a diversified portfolio that will meet your current goals and those you have for tomorrow.