Why the Stock Market Excelled Last Quarter

The stock market turned in a solid quarter with the Total US stock market gaining 6.1 percent. The sensational headlines were proclaiming that the "Dow Has Best Start Since 1999." It was a quarter for small company stocks, as the total return of the S&P 500 was only 5.9 percent, while the Wilshire 4,500 (US stocks not in the S&P 500) turned in a 7.9 percent return. The media offered explanations for the market's performance each and every day. Getting out of the trees and looking at the forest is another matter. Here's what really happened.

News in Q1
Let's take a look at some of the more significant world events in our global economy that have occurred recently.

Bad News For Markets

Several countries in the Middle East erupt in revolution, leaving the world to wonder who will step up to fill the leadership void, and whether it will be Al-Qaeda.
Japan is hit with a mega-quake and accompanying tsunami, which causes devastation leading to a potential nuclear meltdown.
Inflation begins to rear it's ugly head as the price of oil skyrockets.
Real estate double dip decline continues.
Partisan infighting raises the real threat of a U.S. government shut down in a matter of days.

Good News For Markets

U.S. unemployment declines.

I don't know about you but I'd place the majority of the news above squarely in the negative category. The market hates uncertainty and both the Middle East and the Japanese nuclear reactors are filled with uncertainty. I admit that if I had a crystal ball back before the quarter began, I'd have dumped my equities and lost out on this return.

Why did the market go up in Q1?
I've poured over the media headlines and, for once, most of the media got it right. They noted "investors shrugged off major shocks" as the reason the market went up. What they didn't say is that, yet again, the market fooled us and did the unexplainable, closing above December 31, 2007 pre-crash levels.

Keep in mind, however, that a quarter of a year is a period of time concocted by humans. If, for example, we divided periods into 75 days each, the stock market would have returned under 0.3 percent between December 31, 2010 and March 16, 2011. It was only the last two weeks of the quarter when stocks went on a tear. Naturally, that was just when fickle investors started pulling funds out of U.S. stocks.

My final answer
I have no idea why the stock market went up in Q1. So if I were writing the headlines, they would read something like this:

Stock Market Clocks Respectable 6.1 Percent Quarterly Return - Reasons Unknown.
That human beings demand an explanation for everything, and have a pronounced aversion to randomness, makes this a far from satisfying answer. And accepting that the stock market is a very complex and inscrutable organism that defies prediction is a very difficult task.

In my view, accepting that the stock market is smarter than we are is the key to investing. Harness this mysterious organism by owning all of it and rebalancing whenever the market plunges or skyrockets. Don't believe the gurus that claim to know what will come next. Keep emotions and investments separate.

More on MoneyWatch

Fickle Investors Flee Stocks Again
Japan, The Middle East, and the Market Meltdown
Happy Birthday Bull

Allan Roth

Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.

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