Where Is the Stock Market Headed Next? Part I

Weather is a great metaphor for life – sometimes it’s good, sometimes it’s bad and there’s nothing much you can do about it but carry an umbrella.

~ Terri Guillemets

A couple of weeks ago Kevin at Out of Your Rut asked a question that a lot of people ask themselves and others pretty regularly: Where Do YOU Think the Stock Market Is Headed? He presented both the optimist’s view and the pessimist’s, then challenged readers to answer a series of questions to arrive at their own view of where the stock market might be headed next.

I know there are some who would disagree with the idea of even raising the question. I’ve written a couple of articles about the ostrich effect and the other pitfalls of passive investing recently, so I won’t go into those issues again here. Suffice it to say that I think this “Where Is the Market Headed?” question is one that every investor should ask at least annually, and preferably quarterly. Perhaps a watched pot will never boil, but one left unattended presents its own set of dangers.

Kevin asked  8 questions to help us arrive at our own vision of where the market is headed, so I thought I might throw my 2 cents in on them here. I’m gong to answer the first four today and the next four in Part II. Please check out the original post on Out of Your Rut, read the comments, and then weigh in on the debate either here or on Kevin’s site. We are living in some pretty interesting times right now and it’s fascinating to see how different people are experiencing and reacting to them.

1.  Which Way Do You Think the Stock Market Is Headed?

Long time readers will know that I lean pretty heavily toward the bearish camp. I think we are about 10 years into a secular bear market that could go on for another decade or more. That doesn’t necessarily mean I think the market will go straight down. Rather, I think we are in an extended period of much higher volatility in which we will see large swings in both directions, but with the overall trend heading lower.

I think that the massive rally off the March 9th, 2009 lows was fueled by the fumes of unprecedented monetary and fiscal stimulus injected into the global economy by central banks and governments worldwide, some of whom could afford it (China) and others who could not (almost everyone else). It seems like those fumes are now evaporating and we are finding out that there is not much in the way of real fuel for economic growth. For the near term, I think reality will bite and that means a downward trajectory for the markets with elevated volatility.

2.  Where Do You Think It Will Be One Year from Now?

I’m usually really terrible at answering these questions on specific price targets and time lines. I’ll take a stab at it, but be advised that you’d be better off throwing a dart at a target than basing any of your decisions on my guesses. I think that there’s a better than even chance that markets will retest those March 9th lows sometime in 2010, and that they may even break below them, either this year or on a second retest in 2011. If that happened, it would probably be a good time to start looking for bottoming signals and put a little long term cash to work.

3.  Given All of the Bad News, What Do You Think Will Drive the Market Higher?

I think there are two main ways in which the market could conceivably go higher. One is healthy and the other will only prolong the inevitable a bit more:

  1. Government Intervention: If central banks and/or governments (especially the Chinese) find a way to inject more stimulus into the global economy, traders may put the risk trade back on again and the markets would rally. This is the unhealthy route (the one our leaders chose in 2008) because it involves using debt to combat a debt crisis. A cursory knowledge of basic mathematics is all you need to understand that this is a bad idea. Not only are we adding to the global debt problem, but we are sowing the seeds of future hyperinflation by printing money to finance that debt. More bailouts would throw more fuel on the moral hazard fire as well and perpetuate the vicious cycle of boom and bust to which we’ve been subject for quite some time now.
  2. Reality Check: If the markets are able to face the reality of the tenuous global debt situation and send a message to governments that further fiscal imprudence will not be tolerated, we could find a real bottom, from which a more sustainable base can be formed. Granted, this message would be sent by way of a pretty big drop in both the equity and bond markets, with higher interest rates and lower stock prices resulting. Still, I think this type of forest fire is just what we need to finally clear out the dead wood (over-leveraged entities). We will then have fertile ground on which to build a healthier economy. It will not be easy, but sometimes the rocky path is the right one.

4.  What Percentage of a Person’s Portfolio Should Be in Stocks Right Now?

Obviously there can be no one size fits all answer to this question. But in the interest of providing some sort of opinion on the question I would say the following: Whatever your preferred equity allocation would be based on your age and risk tolerance, take that percentage and make it smaller. The closer you are to retirement, the smaller it should be.

If you are already in retirement and are not an agile trader, I would recommend an equity allocation of 0% or close to it. This is a safety-first market climate, not fit for the inexperienced, less knowledgeable, or risk-averse investor. Even many experienced traders have been tapped out by the margin clerk over the past decade. Buy and holders haven’t fared well either.

As in the opening quote, I’ve often used weather as a metaphor for the markets and for life. Predicting the movements of markets and economies seems even more difficult than predicting the weather. The point of trying to do so is not to get the forecast exactly right, but to have an idea how to dress properly for the climate at hand and a backup plan for what to do in case you’re wrong.

Tune in on Thursday for Part II of this article and my answers to the next 4 questions in Kevin’s article.

How would you answer any or all of these 4 questions? Do you think it’s even worthwhile to try?

Written by Kim Petch

13 Responses to Where Is the Stock Market Headed Next? Part I

  1. Excellent job addressing the questions in my original article! This was the kind of dialogue I was going for.

    I don’t have strong feelings on any of this, mainly because I believe the markets are so complicated by external factors, and believe it or not, insulated from reality.

    The possibilities of where it can go are endless, from crash to boom, but I think your advice is outstanding.

    • Thanks Kevin. I loved that you gave us some specific questions to answer. Markets are too complicated to give a one word answer to the question on where they’re going next. Your article did an excellent job of framing the issues that currently face investors and encouraging us to give them some real thought.

      Thanks for stopping by! :)

  2. You have presented an excellent overall picture of what is happening and why it did. Congrats on that.
    However, this compliment is given probably because I agree with your assumptions! LOL!

    • Thank you Pacific. It’s nice to hear from someone who agrees with these ideas, although I am aware that there are those who disagree. And there are still others who are wondering why we even bother asking these questions. Those are the buy and holders. I guess that’s what makes a market. Thanks for your input! :)

  3. After being in the financial industry for 20 years, my conclusion is to stop guessing and focus your energy on what you can control. You can’t control, nor predict the markets so the 9th question should be “What if you are wrong in your guess?”

    • I can certainly understand not wanting to predict the market in the very short term. But I still think it can be useful to understand the issues that could lead to major trend changes and adjust your allocation accordingly. Don’t forget that if you are invested in stocks, you are effectively predicting they will go higher. If they don’t, you will lose money. In all cases, I think you’re right to ask “What if I’m wrong?”.

      The current market environment is very unique compared to anything most of us have seen in our lifetime. As a result, more caution than usual is warranted. (IMHO ;))

    • I liked your article Andrew. I’ve heard a lot of folks compare the current environment to the one we had in the 70s. I think this one will play out a little differently, but in the end will present us with a good buying opportunity. I just don’t know when that will be.

      It’s my contention that we haven’t hit that maximum pain level yet because we haven’t been allowed to do so. The monetary and fiscal authorities keep bailing out the fiscally irresponsible with our money. Until that stops, the ultimate bottom remains elusive.

      Thanks for weighing in and for pointing us to your excellent article!

  4. I think the tough thing about getting that eventual “buy” signal is that, historically, that buy or sell signal never comes. And then we miss it.

    I have no idea what’s going to happen. But despite our issues, we aren’t dealing with stratospheric Japanese price levels. Coupled with the monetary issues today—that would really freak me out.

    This is what I think and hope:

    1. I think current levels are going to prove to be reasonable long term. I recently put my wallet on it, selling some short term Canadian government bonds to invest $65,000 in Coke shares http://andrewhallam.com/coca-cola-the-world%e2%80%99s-easiest-business-to-value/ and $25,000 in the first world international index (VEA)

    2. Considering that I don’t expect to spend this money for another 20 years, I am hoping that the market gets hammered,and I hope it stays down for a long time, so I can buy a lot more over the next 10 to 15 years. I’m down to roughly 35% short term Canadian bonds, but would love to sell more bonds to buy more equities if the markets “behave” and fall a lot lower.

    • It really is hard (maybe even impossible) to catch the exact bottom. And it certainly is possible to become paralyzed once it happens and miss it. But I would still rather be late than lose a lot of money trying to catch a falling knife.

      I hope your Coke position works out for you. I’m not familiar with the VEA index fund you mentioned. Is that similar to the MSCI EAFE?

  5. I think the falling knife concept is just psychological. Like Buffett suggests, if somebody told him what the future interest rates or monetary policy were going to be for the next decade, it wouldn’t change a thing he did. He just buys good businesses at (or below) intrinsic value, which is, I believe, what I did. Where it goes in the short term doesn’t concern me at all. In fact, if that knife falls, I’ll be happy. It’s going to cut fruit all the way down for me, rather than cut my hand.

    The VEA (offered by Vanguard on the NYSE) is the EAFE index, but it differs from the Toronto Stock exchange XIN EAFE index that you might be used to. It isn’t hedged to the Canadian dollar, so overall, it will outperform XIN by roughly 1% each year. Hedging an index like XIN does is expensive, and it has no long term reward.

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