The Ability to React vs. The Abil-ity to Predict
Following steep declines of about 8% and 5% inMay and June, respectively, July was a stellarmonth for the S&P 500, posting about a 7% re-turn, the best monthly result in a year. Yet, de-spite being up over 8% in mid-April, the S&P wasbasically flat for the first seven months of the
year, Since it is not likely that the “true” econ-
omy, valued on a discounted basis by the stock market, really gyrated in value to this extent,what explains this volatility? Even more impor-tant, how does one invest in this environment?In a nutshell, the market is driven by two primaryforces: publication of corporate earnings andeconomic reports, and fear/greed as markets be-come (seemingly) overbought/oversold, respec-tively.On the economic front, at the risk of oversimpli-fying, there have been two competing messages:
A deteriorating economy in the U.S. with per-sistently high unemployment and a growingfear of deflation (which would exacerbate un-employment if it were to occur); and
Corporate earnings and revenue reports that,on average, have been beating expectationsalong with pronouncements by the Fed thatthey will aggressively address further setbacksin the economy, especially deflation.
What’s important to remember here is that the
stock market and the U.S. economy, while related,are two different things. First, although the im-pact of the U.S. economy is felt throughout theworld, it represents only about 25% of the
world’s economy. Second, some 40% of profits of
S&P 500 companies derives from overseas.So, from an equity investing standpoint, a focus onmarket segments that are expected to benefitfrom above average growth are going to be themost successful. Geographically speaking, there iswide-spread agreement at the moment that thatmeans the emerging markets of Latin Americaand Asia/Pacific (excluding Japan).
Second, it’s hard to say exactly when fear or
greed will take control of the market and to whatextent. The degree with which it takes control isusually a function of the length of time the oppo-site influence was in control (see page 3 for visualevidence).
Let’s back up a few steps. The world’s economy is
a big ship. It takes a lot to change its pace of growth and the rate of change in the underlyingeconomy is usually slow. So, when the marketmoves faster than the underlying economy, fearand greed take over. At that point, the marketbecomes less rational (that is, less based on thefundamentals) and is brought back to its longerterm trend or, more likely, overshoots that trendby emotional forces triggered by fear or greed.So, where does this leave us with regard to in-
Stock Market Commentary
August 4, 2010
Lane Asset Management
Many investment profes-sionals and economists,not to mention the Fed-eral Reserve, are predict-ing slow growth for thenext 6-36 months, if not adownright double-dip re-cession. Leading econo-mists are now discussingan increasing potential fordeflation. Yet, the S&Phad its best month in ayear during July.Investing in such an envi-ronment can be nerveracking, to say the least.In this Commentary, I of-fer one way to try to meetthis challenge.As always, I welcome yourcomments and sugges-tions.
vestment strategy. Here are my thoughts:
It is important to have a perspective on the
fundamental direction of the world’s major
economies in order to have a framework toinform investment decisions. While analystscan disagree on what that direction is. Myown view is that the U.S. economy is going tostruggle as long as the political environmentremains so deadlocked. Emerging economiesin Latin America and Asia/Pacific (ex Japan) willdrive global growth. Candidly, I am less clearabout the relative contribution from Europe.
Technical analysis of markets, expressedthrough momentum indicators, offers one of the best opportunities to obtain relative out-performance by reacting. Technical analysismust be considered within the context of an
investor’s risk tolerance and investment time
frame. Assuming an allocation to large cap eq-uities represented by the S&P 500, the chartson pages 2 and 3 suggest the potential forshort term gains and a more clouded picture
for the longer term. The “flat lining” of the
moving averages in each chart present a moredifficult picture to interpret.
Technical analysis is not perfect and providesno guarantee of performance. Nor does onewho follows this investment strategy as, in allhonesty, I can attest.