A Market on the Rebound?

The stock market has been on the rise. Yippee!

On March 9, the Dow (DJIA) hit a new low, closing at 6,547 – its lowest mark in a long, long time. Less than a month later, the same index hit an intra-day high of 8,075 on April 2. Hurrah! Hurrah! We’re up by over 23% since we hit that low.

We all heave a sigh of relief. Better days must be ahead, surely…?!?! Or are they?

Should we abandon all caution and start betting whatever’s left of the family home and the kitchen sink into new investments in the stock market and hope to recoup some of what we had lost in the downturn which began over a year ago? Should we take the risk now in order to be early to the game – after all, the early bird catches the worm?

Like you, I have been tempted. I like to be optimistic but I am hesitant. I’m not sure if the extended market uptick of late is based on solid evidence of improving performance or if it is the beginning of another round of “irrational exuberance”?

The trouble with looking at stock indices as a guide for how well the economy is doing (or is projected to be doing) is that the stock markets take into account forward looking estimates which are purely conjectures – assumptions based on other assumptions which in turn are based on further assumptions.

Lest we forget, faulty assumptions were essentially what brought about the dramatic economic downturn. There were too many untested and unrealistic assumptions:

- The assumption that bankers and builders took, that home prices can continue its spectacular rise although the take home pay of the average worker has stayed flat or that it has decreased in real terms or that job growth has been dismal.

- The assumption commodities traders took, that crude oil and gasoline prices can hit new highs everyday with no impact to the end products or services costs and the consumers’ ability to consume.

- The assumption that credit default swap insurers took, that the risks attached to mortgaged based securities are more hinged on the issuing party’s credit rating rather than the ability of the consumer to service the underlying mortgages.

- The assumption that executives at various corporations took, when they sent all kinds of jobs overseas to improve their bottom line (and to get a bigger profit based incentive bonus), never considering the impact that the loss of jobs en masse have on the ability of Americans to consume those very same products or services they produce.

- The assumption that the authorities took, that regulations are unnecessary and that the markets will regulate themselves as the market players will act wisely.

We were all too seduced by the idea of fast money and instant wealth that we lost sight of the risks and consequences of faulty assumptions and the need to understand and manage them.

Despite the outcry and objections of some, the government has (wisely or unwisely) poured in trillions to stave off economic disaster and to bolster confidence. The players are coming back into the market and credit is ‘loosening up’ but that does not mean that the economy is well. It will take time to heal.

Credit is only useful if consumers have the means or ability to borrow and that depends on their capacity to repay which in turn depends on their income, which in most cases, depends on them having jobs.

Similarly, corporations will borrow to invest in production capacity only if they believe that there will be a demand on their goods or services and that again will depend on consumers having the capacity to spend which again depends on whether they have jobs.

Until you hear that new jobs are being created and the employment trend is on the upswing, don’t believe everything you see or hear about the market on the rebound. The job creation effect of the multiple stimulus packages will take time to make its way through the system before the economic recovery can be on a steady path.

Keep your eyes open and your ears pinned to the ground to watch out for significant projects and events that create a demand for workers or raw materials. When you do, that will be the time to put your money into investments that will benefit from the positive impact.

In the meantime, if you “play” the market as an individual, know for sure that you are putting your money at risk, betting blindly that the index will go one way or the other. It is like rolling the dice and hoping for the best.

I guess I’ll never be filthy rich because I am inherently not a speculator. It is OK with me. I sleep better at night not having to worry about the bad assumptions or the risks.

[Addendum: The above was posted on April 2. On April 3, the Bureau of Labor Statistics reported that unemployment climbed to 8.5% in March (up from 8.1% in February) with the US economy shedding another 663,000 jobs in the month. The Bureau also adjusted the January newly unemployed numbers from from 655,000 to 741,000.]