Markets hate both bad news and uncertainty. With the political unrest in the middle east, and the mega-disaster in Japan, we've had a large dosage of both. What will come next? Will it be a strong recovery, or the beginning of the third 50+ percent plunge of this decade? Let's look at some evidence.
The US stock market plummeted more than 55 percent between October 9, 2007 and March 9, 2009. It recovered to within 3.7 percent of this high last month, before the decline began. In the last several weeks, US stocks have lost more than five percent of their value while international stocks have nearly doubled this loss. March has not been kind to investors so far.
Optimistic Scenario - Remember last May
The headlines ten months ago read "Worst May for the Dow in 70 Years." The BP rig was polluting our oceans and it suddenly seemed risky to be invested in the stock market. Though the economic news wasn't as gloomy as it was back in early 2009, fear was making a strong comeback. Even so, US stocks rose 17.5 percent during the remainder of the year.
Because markets usually do better after news has been bad, this gives us some realistic hope for optimism. The tragic Japan earthquake and tsunami was bad enough but the threat of a nuclear meltdown is downright scary. And who knows what the mid-east will look like after the revolutions are over.
This is all good news for the future performance of markets because the market has already reacted to the disaster and uncertainty. Sure, things could get worse, yet I suspect the market prices in a bad case scenario.
Pessimistic Scenario â€" Investor Behavior and Cramer
I don't mean to minimize the impact of a potential nuclear meltdown in Japan or the whole middle east looking like Iran. What makes me more nervous, however, is investor behavior and Cramer.
I've noted that investors have recently become risk tolerant again and are pouring cash into the stock market. If ever there was a contrary indicator, investor behavior is the ticket. Investors have an incredible track record in this century of being greedy in 2000 and 2007, only to panic after each plunge. I wrote on why I was nervous about the market being overvalued and investor optimism was number one on that list.
And, if this isn't scary enough, the first thing I saw on the web today was that Mad Money's Jim Cramer is a buyer, not a seller. He states, "natural disasters spur economic activity, and ultimately that's good news for stocks." This comes from the man who said Lehman Brothers was not in trouble and, after the plunge, came to the realization that the stock market is too risky for those needing the cash in the next five years.
My Advice â€" Nearly as Valuable as a Crystal Ball
While I wish I had a crystal ball, I have long ago accepted the fact that it's really hard to predict the future of the stock market. What will work going forward is discipline. This discipline must include:
1. Setting an asset allocation policy and sticking to it.
2. Remembering that when news is gloomy, it's probably time to rebalance.
3. Accepting that investing is painful and being willing to handle the pain.
Check out Jill Schlesinger's 5 Investor lessons from the Japan earthquake. She provides a nice dosage of discipline.
Volatile markets are here to stay. The more volatile the markets, the greater the profits from this disciplined strategy.
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