No, You Haven’t Missed Out

Thursday, October 1, 2009

Waiting for trainThe quarter is over and now we will read all about the market’s dazzling 50% climb in only six months. The write-ups will imply that loads of investors happily saw it coming and got in early – but not too early. A second message will be that if you didn’t get in, too bad for you, because it’s too late now. This annoying semantic game gets played after every big stock market move and can cause investors dismay and lead them to hesitate. These messages are wrong and should be ignored. Here’s how to think about the 50% rise.

Generally, a company’s common stock price reflects its current position and future prospects. The price moves around as analysts update their forecasts and portfolio managers alter their holdings, but it is generally linked to the company’s fundamentals.

However, two things can throw a monkey wrench into that relationship: uncertainty and emotions.

Uncertainty, like the period we have been in, causes analyst forecasts to become foggy, adding risk to stock investing. When that happens, prices tend to go lower.

Emotions play a large role when many or most investors feel the same way, leading to an optimistic or pessimistic overlay. Such times are temporary. When they end the price eventually returns to a normal valuation level.

The market we have seen over the past year has had it all: vacillating fundamental valuation, gobs of uncertainty and waves of pessimism. There were two particular points when the perfect storm came together:

First, in late September/early October 2008, company fundamentals unraveled, uncertainty about the future skyrocketed and there was tsunami of pessimism and fear that drove the stock market down. In two weeks, it fell almost 25%.

Then, in February through early March 2009, the three came together again, but in a different way. Analysts had a better grip on the poor fundamentals. Uncertainty stopped getting worse. Fear-driven selling had abated. But there was little good news and the market was back to its October lows. Finally, it broke down as investors with cash sat on the sidelines. The market went into a steady one-month slide, dropping about 20%.

It was at the end of that slide in mid-March that some buyers began to buy at those very low prices, taking the market back up almost 25% to its February levels. (Note: it takes a 25% rise to offset a 20% decline.)

Since then, fundamentals have improved, uncertainty has dropped and emotions have moved away from pessimism.

And this is why I say it’s not too late. The 50% gain, while large, was off a very low base. We are not yet back to normal valuations, nor are we back to a normally operating economy. When that happens, prices could be much higher, with investors once again focusing  on future company prospects. Uncertainty and pessimism will be just a memory.

DJIA daily.xls-edited

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