What is the Market Outlook Now?

Although the powers that be have yet to officially decree it, the 3^rd quarter most likely represent the end of the recession. A year after the collapse of Lehman Brothers sent credit markets into a tailspin, the markets are signaling the economy has finally found its bottom and is now trying to dig itself out of a deep hole.  Huge challenges remain, but the worst may be over. In fact, the US markets have posted their best quarter in over 10 years. Looking forward, we remain cautiously optimistic – and want to share some thoughts on where markets stand today and what we’re recommending right now.

Only with the benefit of hindsight do we realize how much the market had going for it in early March of this year. Sentiment was excessively pessimistic (a good contrarian indicator for the market), valuations were exceptionally low (especially given what we now know was a forward earnings bar set too low), and cash "on the sidelines" was in the stratosphere.

Fast forward to today: By no means are we in dire straits, but sentiment has been bumping into the extreme optimism zone, a lot of cash has been put to work (admittedly more on the fixed income side than in equities) and valuations are less compelling. It always seems darkest right before the dawn.

As a result, we’ve had a strong recovery in markets – from their bottom in the beginning of March, stock markets are up considerably retracing a good portion of the losses since last fall.

Here are a few lessons from the last twelve months:

1. We were reminded of just how volatile stocks are.

2. And of the importance of having a financial plan.

3. Many investors discovered that they’re less comfortable with risk and volatility in their portfolio than they had believed.

4. Investors were also reminded of the need to focus on what they can control – understanding their cash needs and thinking through how much risk they can tolerate to fund those needs.

5. In some cases, investors began rethinking retirement plans as a result.

6. Finally, we were reminded, we can’t predict the future, but we can plan for it.

Where we are today

Two years ago, the market was characterized by abundant optimism. The U.S. market had hit a new high in November of 2007 and any concerns were set aside as minor nuisances. By contrast, six months ago the market was overwhelmed by complete pessimism – there was no sign of hope anywhere. Today, the market is somewhere between those two extremes and many investors can be characterized as extremely nervous.

As a general rule, a certain level of healthy anxiety is positive (markets tend to climb a “wall of worry”) – what gets investors in trouble is an excess of either optimism or pessimism. While today’s mood may be a bit too pessimistic, being cautious in the current market makes sense … provided that prudent caution doesn’t cross the line into panicked inertia or hasty decisions.

The good news is that there are still excellent opportunities for investors who are prepared for short term volatility. We spend a lot of time listening to the best market minds and to managers who have lived through multiple cycles. We are reassured that most say that they are still finding very good.

The outlook going forward

In August, Business Week ran a cover story called “The case for optimism.” The premise was simple: Beyond the issues facing the global economy, there are many underlying positives that give cause for optimism if we look out two or three years or beyond.

Powerful forces under the surface will drive economic growth … and that economic growth will drive stock prices. Examples include the positive impact of technology, the recovering US housing market, the revitalization of economies and the incredible energy from the developing world’s educated youth and emerging middle class.

Click here to access the Business Week stories on The Case for Optimism.

And here to view a three-minute video with interviews with CEOs of Dow Corning, Eastman Kodak and Intuit.

And there are more articles we've collected over the last couple months expressing the same view (see below).

While the easiest profits may be behind us, we still see good opportunities as the market tends to “climb a wall of worry.”  Going forward, expect continued volatility and headlines that will cause investor concern (higher un-employment, talk of inflation, etc). As a result, we are continuing to focus on balanced, diversified portfolios.

One of the important lessons from 2008 was the critical importance of Risk Management.  There is always some degree of risk present in every investment purchased. We tend to scale into positions over time (dollar-cost-averaging). Have you ever thought about “dollar cost averaging” in reverse? By avoiding or minimizing specific types of risk, one can keep temporary hiccups in the economy or financial markets from destroying one’s wealth. Smart investing includes risk management – when to buy & when to sell.

We continue to monitor any signs of significantly higher inflation or of corporate earnings coming in below expectations, either of which would cause a rethinking our portfolio strategy. Remember, my team and I are always here should you have any questions or wish to talk about anything related to your portfolio or your finances.