Chicken Little Should Have Had a Better Memory?

We all remember the fable about Chicken Little who when hit on the head by a falling acorn, decided that the sky was falling—instigating a panic in the community as everyone tried to save themselves from the impending doom. Who would have thought that a possible default in a country the size of Greece would have set off the events of the past week? Particularly since the problems in Greece have been in the news for months.

But, this is how markets work. In the short term, market values are based on perceptions of the future, or in other words, pure psychology. Should we have seen this coming and sold investments? You can’t shoot your herd of cattle just because there is a risk of a stampede! These types of panics can happen at any time.

As investors, we have always known that we have to co-exist with “gamblers” or traders who are always trying to make fast money by betting with each other. Believe it or not, they really do provide a benefit in the form of liquidity and increased market volume. The price we and they pay for this liquidity however is in the form of volatility. What is new is the fact that these gamblers are now armed with increasingly powerful computers driven by computer programs or algorithms designed to exploit minute market movements and to “protect” the gamblers from market falls. If and when these programs all decide, at the same time, that the market is going in the “wrong” direction, they can create awe inspiring market movements like we saw this week.

In response to market volatility in 1987 caused by computer program trading and so called automatic sell programs called “portfolio insurance” the NYSE instituted “circuit breakers” or mandatory pauses in trading. These rules were revised in 1998. The current rules are shown on the website www.nyse.com. Interestingly, no trading halts are set to occur between 2:30PM and 4:00PM ET! It appears that perhaps the new “program trading” algorithms have adapted to this as the “big event” this week occurred after 2:30PM! We may never know exactly what happened, but in an auction market like the stock market—when there are no buyers, prices can get very low, very fast. Especially when computers, not humans are carrying out the bulk of the buys and sells. And, especially with increased potential volume as the result of a dramatically increased activity in derivatives and options. Most likely computer programs began selling and created a vicious cycle as stop loss orders to protect against loss kicked in, creating a tsunami of sell orders with no buy orders until prices fell substantially.

Back to the credit crisis concerns about Greece that seemed to light the fuse this week. We have seen this type of thing before. In 1997 we had the Asian Credit Crisis, followed a year later by the Russia’s debt default in 1998. Then in 2001, Argentina defaulted on $132 Billion in sovereign debt—about the same that is at risk in Greece. (Greece’s and Argentina’s economies are about the same. Greece’s economy is only 0.3% of the world’s GDP.)

Let’s put things in a bit of perspective. In early October 1997 the Dow was at 8178. When the Asian Crisis created a reaction, the Dow fell 12.5% to 7161. Eight months later, the Dow had risen 30% to 9328. Reaction to the Russian default in August 1998 caused the Dow to drop 16% to 7827, still 9% higher than the low after the Asian Crisis. The Dow then rose to 11772 by January 2000, falling to 7528 in October 2002. By October 2007, the Dow had risen to 14066. In 10 years from October 1997 to October 2007, the Dow rose from 8178 to 14066, thru three credit crises and a terrible bear market in 2000-2003.

So here we are again with a credit crisis, where fear of contagion causes a bit of panic. The Dow falls 7.4% in days from 11205 on April 26 to 10380 on May 7. Is it over? Probably not yet. The Dow closed at 10325 on the last day of February. Many gamblers may not feel that it is safe to get back into the water until we see a classic 10% “correction”. So, many are probably looking for the Dow to fall at least another 2.3% to 10084. (The Dow was 9908 on 2/8/2010.) Nobody knows for sure when it will change direction. It will change only when the perception of the future changes.

Economic cycles have always more or less been driven by debt. Increased borrowing tends to increase economic growth until the borrowing reaches a point where debtors cannot service it. Then there is a period where debts are restricted or written off and losses are recognized. Decreased borrowing tends to curtail growth.

One big fear is that, even though the US seems to be in a strong economic recovery, that problems in Europe will curtail economic recovery there. And, with a weak Europe, China’s export machine sputters, and the outlook for continued growth in the US is diminished. Another fear is that terrorism is on the rise. Another fear is that governments around the world seem to be taking on too much debt.

It has been said that the most dangerous words related to predicting the future of economies and markets are: “But this time it is different”

The best advice is always to study history and learn from it. Markets in the short term are driven by fear and greed. Market movements are exaggerated by the actions of gamblers. It must be remembered that sovereign debt problems, like unemployment tend to be a lagging indicator, not a leading one. Investors know that markets fluctuate but in the long run, stock markets return to the value determined by corporate profits. Few would argue that corporate profits are not in an upward trend. The debate is really about how fast they will increase. If and when you are confident of the trend, then use the exaggerated market movements caused by fear, greed and the foolish activities of gamblers to your advantage.

If your money is invested for the long term—five years, ten years or more, and you have income or resources to support yourself in the near term, then stay invested. If you have excess resources, then low prices and fear are an invitation for you to profit—the last week has produced a renewed list of opportunities.

If you are a gambler, I can’t help you since I do not provide advice or education to gamblers.

And if you are an investor, when you hear the cries of Chicken Little, tell him he should have a better memory.

This post is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. 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.

Should you be afraid of September and October?

Invariably, the media will begin to write stories about how September and October have been historically bad months for the stock market. Given market declines in September and October of 2008; along with the human tendency to overweight recent data; and the recent market gains: there is likely to be a lot of anxiety this year.

It is true that on AVERAGE, returns during September have been negative. October has not been a particularly good month either, on AVERAGE, but contrary to popular myth, September on AVERAGE has been worse than October.

But the term “on AVERAGE” fails to inform that returns during September and October have been positive in many years. Negative returns in some years tend to overshadow the smaller positive returns in other years.

Using data for the last 20 years, returns during 50% of the September periods have been negative. For October, the percentage is a low 30%. Using data for the last 40 years, there was a 50% chance of a decline in September and a 38% chance in October. During the period from 1897-2007, the DOW has fallen in September 59% of the time, and 41% in October. During September periods following periods of a rising market (like this year) returns have been negative 82% of the time. (With a 1.73% decline on AVERAGE.)

I think the important take away is that you should not be afraid of the calendar. Markets move because of fundamentals and sentiment. Investing is about looking forward, not backward. Markets may tend to decline in September because of fears that corporate earnings in the October “Earnings Season” may fail to meet expectations, but it is unlikely that they will fall just because markets have fallen in previous Septembers.

The good news for long term investors is that since 1960, there has been a “pattern” where markets “typically” rise in the September-December period, with a rally late in the year more than compensating for a small decline in September/October.

There are many that are waiting for a “correction” because they feel we have come too far, too fast. On the other hand, we are still 34% below the recent peak in October 2007 and markets would have to rise another 51% to reach that peak. Fundamentals and sentiment are both improving and there is still a lot of cash waiting to come into the market.

So, except for day traders trying to profit from short term market movements, prudent long term investors would probably be wise to begin putting excess cash to work according to an organized plan and entry strategy designed to allow them to reach their long term goals.

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. 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.

Déjà vu? Be Cautious, Patient and Look For Opportunity

We have seen bull markets coming out of a recession continuing into July and August before.

In 1933, markets had a huge rally of more than 100% (doubling) from February, ending on July 17, with an 18% correction following in short order. (See previous blog, Perspective from 1933.)

In 1975, a rally of 53% occurred starting in October 1974, with nearly a 14% correction in August and September.

In 2003, markets rose from March to July by more than 25%, with a small 5% correction.

In all three cases, markets returned to the previous high within 5 months. So in each case, the correction was a “buying opportunity”.

So far this year, we’ve seen a rally of around 50% right up to “options expiration” week in August. The S&P500 closed on 8/21/09 at 1026. A 5% correction (2003 level) would take us to 975. A 14% correction (1975 level) would take the S&P 500 to 882. This is not 1933, 2003 nor 1975, however, I have said before that this market “feels” like the 1970’s.

Nobody can predict the exact timing or extent of market movements, but history does teach us that markets fluctuate and tend to take a “rest” and “correct” after big gains that occur over short periods.

For long term investors already invested, these corrections may not be worth the transaction costs of making big changes, but for those with cash on the sidelines, they present an opportunity.

The recent moves have clearly been the result of cash piling into the market. I wrote in July, “But, when the majority do believe (that the worst is over), the tsunami of cash coming into the market may result in impressive gains.” Impressive indeed! This new cash came in because so many companies “beat analyst’s estimates”. So July and early August will probably be deemed the “relief” rally with greed and fear of missing out overwhelming those that fear loss.

Now the market will begin to ruminate about what earnings will be for the next few quarters. If no bad news comes out, markets may continue to rise. Momentum is important. Keep in mind, we are still 21% below August 28, 2008. We would need another 26% rise to reach that 1300 level. But, many will begin to fret that we have come too far too fast. History teaches us that there will probably (but not certainly) be a “buying opportunity” soon.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation. 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.

Buy and Hold--Is There a Better Way?

Modern Portfolio Theory—Is it really so Modern?

Fifty years ago, in 1959, Harry Markowitz proposed that investors expect to be compensated for risk and that an infinite number of “efficient” portfolios exist along a curve called the “efficient frontier”. The formula used to create this “efficient frontier” is known as mean variance optimization or MVO. It is the basis for what has become known as Modern Portfolio Theory. Markowitz and William Sharpe, the inventor of the Capital Asset Pricing Model shared a Nobel Prize in 1990 for their work.

This highly theoretical and academic work was widely adopted by the investment community. The “method” became: Choose a risk level you are comfortable with and then build a portfolio of diversified investments that match the efficient frontier and you can predict your probable or expected return. Wait long enough and your return would most surely be the magic number predicted by the efficient frontier curve for your level of risk. Maybe….

The efficient frontier is defined by three variables: standard deviation, correlation coefficient/s, and return. The basis of MPT is that investors are rational and that they will always seek out the most efficient portfolio—the highest return for their acceptable risk level.

After Markowitz came another academic, a Eugene Fama who postulated that markets are efficient with all participants acting rationally with complete information and therefore securities are accurately priced most of the time. This was expanded by Burton Malkiel who wrote the book, The Random Walk Down Wall Street. This led to what is now known as the Efficient Market Hypothesis or EMH.

All this academic theory and hypotheses essentially got wrapped up into one big concept: “Buy and Hold”. Hire a professional to build an “efficient” portfolio and keep and eye on it—wait a sufficient period of time and make money! Maybe not…

Rational Expectations versus Rational Beliefs

Most economic theory is based on Rational Expectations. In other words people act with their best guess of the future (the optimal forecast) that uses all available information. It somehow assumes that everyone has the same information and therefore everybody’s “rational” best guess is the same. If they act differently, then they are irrational. This has always seemed a little silly to me, but it seemed to help explain many things.

A Stanford University Professor named Mordecai Kurz began to question the concept of Rational Expectations, and became known as the father of Rational Beliefs Theory. It is a subtle difference, but essentially it says that people will act according to their “beliefs” and that many different beliefs exist at the same time. As long as people act according to their beliefs, they are acting rationally.

Kurz essentially explains how markets can be crazy without having to refute that people have similar access to the same information. It does not require us to assume that people are crazy. Different people have different beliefs while having the same information. People change their beliefs when proven wrong either by facts or sometimes by herd behavior. It essentially states that people change their minds.

Post Modern Portfolio Theory and Downside Risk Optimization

Post Modern Portfolio Theory assumes that people seek to avoid loss more than they seek large gains. (Fear of loss is exponential and there is a leakage of utility on the upside.) It also assumes that most investors have a minimum acceptable return or MAR. Returns below the MAR are what investors fear much more than mere “fluctuation”. Modern Portfolio Theory has been developed and promoted by Frank Sortino of the Pension Research Institute. He developed a measure of risk called the Sortino Ratio.

Dynamic Asset Allocation vs. Buy and Hold

While MPT leads to “static” Buy and Hold portfolios, PMPT and the Rational Beliefs Theory assumes that the world is a changing place—concluding that a “Dynamic Asset Allocation” is more appropriate. Dynamic Asset Allocation requires a changing portfolio. Changes will be based on exploiting inefficiencies in markets and adapting the portfolio to the current situation as well as possible future situations. The current situation is created by varying beliefs regarding the future held by all the different market participants. In other words, the optimum portfolio is that that which addresses the owner’s MAR and belief/s regarding the future--thereby optimizing downside risk. It is also based on our ability to have some idea how other investors beliefs are correlated and how they may change in the future.

Reasonably Reliable Leading Indicators (RRLI’s)

I have always assumed that technical analysis was sort of like the “reading of the bones” by shaman and witch doctors---looking for meaning in meaningless patterns. However, since human nature drives markets, and human nature tends to be relatively constant, we may be able to ascertain present investor beliefs based on market behavior—to a degree. These present market beliefs may be part of a pattern that has occurred in the past, and certain market behavior may signal a future change in how investors’ beliefs will be correlated in the future. Some indicators are considered technical and others may actually be more fundamental where they signal a situation that will actually cause a change in markets.

None of these “indicators” are perfect. They may be predictive only 60-70% of the time. One thing we know, when many indicators point to the same conclusion, the probability of that conclusion being correct increases significantly. They provide a useful set of tools when the goal is a Dynamic Asset Allocation. Remember that Dynamic Asset Allocation is not the same thing as market timing—we are seeking return with downside risk considered and not just the highest possible return. We may avoid a possible profit opportunity if the risk of loss is small but the possible size of the loss is too large for us to tolerate.

Here is a limited list of some relatively powerful Reasonably Reliable Leading Indictors: A) The US Treasury Yield Curve; B) The Corporate to Government Bond Yield Spread; C) The occurrence of Black and Golden Crosses, and D) The Relative Strength Index.

The US Treasury Yield Curve or the difference in rates for short term vs. long term is a very useful indicator. When it goes inverted it is a strong indicator of a down market coming. When it has a steep upward slope, it is a reasonably strong bull market indicator. It becomes more accurate the longer it stays in one phase.

The spread or difference between “riskless” government bonds and “risky” corporate bonds tends to correlate with markets being euphoric or risk averse. Inappropriate pricing of risk is a reasonably strong indication that beliefs are highly correlated and likely to change. Euphoria and Emotional Depression are never permanent. They usually represent opportunity for a Dynamic Asset Allocation strategy. As Warren Buffet has said, “buy and be greedy when others are fearful; sell and be fearful when others are greedy”.

Black and Golden Crosses are bear and bull market predictors. The “cross” occurs when the 50 day moving average crosses the 200 day moving average. When the short term average moves higher than the long term, it is a bullish indicator. According to research from one large brokerage, “The S&P500 has had 15 Golden Crosses associated with NBER recessions—these signals on average led to a 19.2% gain one year later”. Golden Crosses tend to be more predictive during a recession. Black Crosses tend to be more predictive after a bull market has become a bit long in the tooth.

The Relative Strength Index is one of many created by J. Welles Wilder and published in his book: New Concepts in Technical Trading Systems in 1978. It can be as complicated as the user desires, but most people use a smoothing factor/period of 14. Most users believe that around 30 is a strong buy signal and 70 is a strong sell signal. The RSI may be useful when entering markets or determining the best time to adjust a dynamic asset allocation.

WS Wealth Managers Inc. uses the above mentioned RRLI’s along with others not mentioned when making judgments about changing asset allocations.

Remember that RRLI’s are never perfect—they increase the probability of being correct, but do not guarantee being correct. That is why we call them “reasonably” reliable. A diversified portfolio made up of quality assets that are somewhat negatively correlated is always more important than attempting to predict the short term future behavior of market participants.

The argument whether markets are random and therefore completely unpredictable, or just chaotic where they appear to be random but are in fact orderly is the same debate that is going on regarding Brownian Motion, Chaos Theory and Fractals. Now that is truly a scientific technical discussion and a topic for another day.

This paper is for educational purposes and for the sake of discussion. It is not a complete discussion regarding portfolio management. It is not a sales presentation and not a recommendation. 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 and fundamental analysis.

The Market is from Missouri

In February I wrote that markets can go up a lot after the inauguration of a new US President, in the midst of a recession. In May I wrote that Hope and Worry would engage in a classic conflict resulting in market volatility with a possible “correction” after hitting a peak. From the March 9 “bottom” the S&P500 rose 40% until falling 7% in June, and rising back 7% to 940 on July 17. So, far, we have witnessed an almost classic panic followed by a euphoric, “the worst must be over” and “we don’t want to miss out” 40% relief rally followed by normal profit taking and uncertainty.

Now, we are in the middle of “earning season” and markets are moved by reported profits; how those profits compare to previous estimates by analysts, and “guidance” from the reporting companies. If companies report good earnings but the CEO is pessimistic about the future, the stock probably goes down. If companies report bad earnings, but beat “expectations” the stock may go up. What in essence is happening is that buyers are waiting for what they believe is evidence of profits in the future—“show me the money”.

There is no doubt that the economy is still a mess. Harley Davidson reported a 30% year over year decline in shipments. GE reported revenues were down 17%. The Fed reports they are concerned about labor markets and increased their unemployment estimates. They indicated that banks could foresee substantial losses in loan portfolios. They described the recovery and current situation as “fragile”. Commercial real estate is in the process of being revalued and recapitalized. Many fear that the pending recovery will be ”jobless” with growing GDP but high unemployment. Citizens are becoming impatient and the new President’s approval rating is falling.

So why does all this bad economic news not result in another leg down for the market, beyond the 7% we recently experienced? Remember that market prices for stocks are driven by expected future profits as well as the willingness of buyers to move out of cash and cash equivalents. As of May 31, 2009, cash/cash equivalents held by individuals and institutions totaled around $7.9 TRILLION—almost enough to buy the entire market value of all 500 companies in the S&P500. If we return to historical norms, nearly $4 TRILLION of cash is waiting to go back into the market. Much of this cash is what I refer to as “anxious” because short term interest rates are so low and people are afraid that markets will “take off” and leave them behind. For most investors, especially mutual fund and pension fund managers, the only thing worse than suffering a decline is not making it up--missing out on the recovery.

So if people from Missouri are skeptical and want to be shown real facts before they believe, the market now has the same attitude. Investors need to be “shown” that the companies are making profits and that future profits will be higher before they will believe that markets will go up. But, when the majority do believe, the tsunami of cash coming into the market may result in impressive gains. The difficult part will be figuring out just how much “proof” the majority will need to make them “believe” that future profits will be higher. This proof will come in the midst of continuing bad news about the present and near future state of the economy. What do they need to be “shown” for them to support their beliefs? One key may be related to improving productivity. There is growing evidence that productivity is increasing dramatically and will show up in corporate profits significantly before the employment picture improves.

Hope and Worry are likely to continue their battle. The Worry crowd will probably drive the market down periodically because of bad news. But investors are generally an optimistic group and those with a cautious but hopeful long term view are likely to be rewarded. We believe the current situation is “yellow” for the near to medium term, but “green” for the long term. Solid companies that have “staying power” with little debt, growing productivity, good products, and reasonable present earnings represent good opportunity and value.

This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.


See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the Commonwealth of Pennsylvania and the State of Maryland. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as Chief Investment Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC. FOLIO Advisor program is available through FOLIOfn Investments Inc. a Member of FINRA and SIPC. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC, Pershing LLC or FOLIOfn Investments Inc..

On Economic Forecasts..Chance Favors a Prepared Mind

Quote from speech by Ben Bernanke at Boston College Commencement 5/22/09:

“As an economist and policymaker, I have plenty of experience in trying to foretell the future, because policy decisions inevitably involve projections of how alternative policy choices will influence the future course of the economy. The Federal Reserve, therefore, devotes substantial resources to economic forecasting. Likewise, individual investors and businesses have strong financial incentives to try to anticipate how the economy will evolve. With so much at stake, you will not be surprised to know that, over the years, many very smart people have applied the most sophisticated statistical and modeling tools available to try to better divine the economic future. But the results, unfortunately, have more often than not been underwhelming. Like weather forecasters, economic forecasters must deal with a system that is extraordinarily complex, that is subject to random shocks, and about which our data and understanding will always be imperfect."

"In some ways, predicting the economy is even more difficult than forecasting the weather, because an economy is not made up of molecules whose behavior is subject to the laws of physics, but rather of human beings who are themselves thinking about the future and whose behavior may be influenced by the forecasts that they or others make. To be sure, historical relationships and regularities can help economists, as well as weather forecasters, gain some insight into the future, but these must be used with considerable caution and healthy skepticism.”

“In planning our own individual lives, we all have a strong psychological need to believe that we can control, or at least anticipate, much of what will happen to us. But the social and physical environments in which we live, and indeed, we ourselves, are complex systems, if you will, subject to diverse and unforeseen influences. Scientists and mathematicians have discussed the so-called butterfly effect, which holds that, in a sufficiently complex system, a small cause--the flapping of a butterfly's wings in Brazil--might conceivably have a disproportionately large effect--a typhoon in the Pacific. All this is to put a scientific gloss on what you probably know from everyday life or from reading good literature: Life is much less predictable than we would wish. As John Lennon once said, "Life is what happens to you while you are busy making other plans."

"Our lack of control over what happens to us might be grounds for an attitude of resignation or fatalism, but I would urge you to take a very different lesson. You may have limited control over the challenges and opportunities you will face, or the good fortune and trials that you will experience. You have considerably more control, however, over how well prepared and open you are, personally and professionally, to make the most of the opportunities that life provides you. Any time that you challenge yourself to undertake something worthwhile but difficult, a little out of your comfort zone--or any time that you put yourself in a position that challenges your preconceived sense of your own limits--you increase your capacity to make the most of the unexpected opportunities with which you will inevitably be presented. Or, to borrow another aphorism, this one from Louis Pasteur: "Chance favors the prepared mind."”

Complete speech available:

http://www.federalreserve.gov/newsevents/speech/bernanke20090522a.htm

At WS Wealth Managers, we always tell our clients that Preparation is more important than Predictions which is another way of saying what Louis Pasteur said: “Chance favors a prepared mind”. Our view is that predicting the short term micro or macro economic future is like predicting the weather—we can only speak in probabilities. On the other hand, predicting what will happen can be done with much more precision than predicting when it will happen. (Assuming the predictor is intelligent and informed.) We can predict that Summer follows Winter. We know that Winter nor Summer do not go on forever. Being prepared is all about knowing what will happen—knowing that when it happens, you will be prepared to take a certain action that benefits you.

Hope vs Worry

In February I wrote: “During periods of high volatility, and even in the middle of very tough economic times, markets can go up a lot.” This continues to be a true and important statement. Since the March 9 “bottom” stocks are up a lot. Is it time to throw caution to the wind? I think not.

Markets are created by buyers who have hope and sellers who have worry. Times of change are characterized by the tension of two competing fears: The Fear of Loss vs. the Fear of Missing Out.

Markets in the short term are driven by these emotions and sentiment. Hence, logic is almost useless as a predictive tool in the short run. In the long term however, markets are priced by the profitability of companies, which is driven by economic activity and increases in productivity over the long run. Logic can be very useful as a predictive tool in the long run.

From it’s peak of nearly $65 trillion in 2007, World Stock Market Capitalization fell below $30 trillion in March 2009. This type of decline has no explanation other than a global panic driven by a level of emotion (fear) and a fall in housing prices that I have not seen in my lifetime. Since this “bottom” in March, it has risen dramatically. In April alone, it rose $4.2 trillion. The only logical explanation is the recent rally is simply a realization that the previous decline was overdone.

You will hear the “worry” crowd pontificating that markets cannot recover until the economy improves. There are many signs that the world economy is still in a great deal of trouble. Unemployment is rising. House prices may fall further. People are spending less. The “hope” crowd however will point out that there are many “green shoots” or signs that things are on the mend: Consumer Sentiment is up; Housing has never been so affordable; Governments worldwide are proactive and are implementing unprecedented pro-growth initiatives; There is a great deal of cash sitting on the sidelines, earning little interest income and poised to enter the stock market. Both crowds are correct. But, most importantly, markets tend to turn upward ahead of the economy.

Within the “worry” crowd is a group who fear that our best times are behind us. They not only fear another decline in the short term but also a long term reduction in enterprise profitability and hence value. Within the “hope” crowd is a group that figures the worst is over and that good times will soon return. Both groups are probably incorrect.

The point here is that good times will return. The unknown is only really how soon and how fast. World stock markets were probably overvalued at $65 trillion in 2007. (Knowing what we now know about excess borrowing and debt.) They were undoubtedly undervalued at $30 trillion in 2009. A case can be made that their “fair” value is between $40-50 trillion. Markets therefore have room to rise. But, their rise is likely to be a roller coaster ride of ups and downs: Hope vs. Worry.

So, investors with a long term outlook should stay invested with a cautious outlook and cash should be deployed cautiously. Continued recession and a recovery with inflation are both very possible outcomes. What you invest in will be very important. Good advice has never been more valuable.