The “correction” we expected as mentioned in our February 26, 2011 article did in fact occur in March. Corrections can be likened to a room with gasoline spilt on the floor—the potential for fire exists—it only awaits the match. In March, the “match” that lit the fire was a combination of a natural disaster in Japan, increasing tensions in the Middle East, and a new “limited” military adventure in Libya. The correction did not last long. After a 5% drop, the S&P500 ended March at the same level that it began.
The list of risks, any of which might derail our recovery seems to be growing. European sovereign debt issues continue. We are now engaged in three military conflicts in a Middle East that seems on the verge of revolution. Some believe the revolution is with the goal of democracy—others fear it is with the goal of radical theocracy. Inflation caused by rising oil prices is threatening to permeate our entire economy. Unemployment is falling, but it is still very high. The residential real estate market continues to be weak, threatening a continuing problem of debt defaults and foreclosures. Conservative and Liberal elements of our society are so diametrically opposed that the path forward regarding government’s role and spending are uncertain. What happens when government spending stimulus is withdrawn? What happens if government deficits continue? What happens after the world’s third largest economy experiences perhaps the most serious natural disaster in modern history? Fear regarding the future value of paper money seems to be creating a new bubble in the price of commodities and precious metals. As my title suggests: the Wall of Worry seems to have gotten taller.
As I have said in the past, a Wall of Worry is an absolute requirement for a continued bull market. It means that there is still a large bank of “potential” buyers. While any of the risks mentioned could cause a fall in markets, it is important to remember that the values of equities depend on the psychological perception about corporate earnings in the long term as compared to interest rates, and a perception of the direction of corporate earnings in the short term.
We are now just at the beginning of “Earnings Season”. Earnings and outlooks from Alcoa, Google, Bank of America and JP Morgan last week produced a bit of anxiety. Be prepared for a great deal of volatility as the markets try to “read” the true meaning of the corporate announcements over the next few weeks. What has been driving the markets up, despite worries, is the belief that the economy is recovering. This is supported by facts. The fear is just about whether this trend and recovery continues.
I am most optimistic about one key indicator. CEO Confidence as measured by the Conference Board is quite high. Says Lynn Franco, Director of The Conference Board Consumer Research Center (April 7): “CEOs’ confidence has improved, yet again, and expectations are that the economy will continue to expand in the coming months. As for the employment outlook, CEOs are more bullish than last year, with half now saying they intend to ramp up hiring.”
Our advice is to remain cautious in the short term. However, we are also convinced that tremendous opportunity exists for those with a long term view. Stay the course, remain conservative and diversified—but keep your eyes peeled for trouble and opportunity—we are likely to see both.
This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.
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