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.