Monday, May 23, 2011

Financial market fragility hits the frontal lobe

It's lizard brain time again. Financial markets have participants on edge. Can traders and investors stay calm or are we on the edge of rash decision making and pundit panic.

Continued sovereign debt challenges in Europe are the biggest threat to create systemic issues and credit market uncertainty. The rating agencies that were completely discredited during the financial crisis now move markets dramatically with their pronouncements on sovereign ratings. Now on the defensive, the agencies can only protect their franchises by focusing on the little picture, looking at any constructive outcomes with anxious bowels. We seem to be stuck with them. Who among the smartest ever left their college or MBA program with the goal of working for a rating agency. Anyone?

The other catalyst for Friday's weakness and today's follow-on was the weak sales and earnings numbers reported by The Gap. While corporate earnings in general have been healthy, the skittish market put Gap in the spotlight. Wait a minute. Isn't this the Gap that is going through a multi-year period of management changes, product differention challenges, and a loss of relevance to any specific customer demographic. The market is in the mood to look for problems.

More important to the economy's outlook is the continued near flatlining of the residential housing market. The foreclosure overhang is well known and the incentives for new investment are few. The cyclical trough is in place until at least 2013. Looking at the 1989 to 1995 period as an indicator, the market will eventually clear, but with the absence of vibrant securtization activity it will do so at a lower pricing level.

On the positive side, as often mentioned here, equity markets do not necessarily require that all boats float. With strong corporate earnings and money looking for a home that offers more than a miniscule money market return, a market sell-off that appears to be widely expected may be short-lived. That thought leaves investors with the current dilemma of whether to lighten up and restructure portfolios now in advance of a downturn or to hang tough and look for buying opportunities. The sell now because of the prospect of buying back cheaper in the near future mentality may be dominant at the moment, but is it wise.

It may finally be the time when investments shift dramatically into the safer large cap dividend paying stocks, those with global exposure and staying power. Any such shift will send the averages down at least temporarily and create greater uncertainty in the short term.

In the absence of a crystal ball, many investors will be inclined to inertia if panic can be forestalled. Old "wisdoms" are now coming out of the mouths of pundits such as "sell in May and come back in November" and "as summer approaches investors go on vacation(literally)". Knee jerk comments such as these are of no value. That's not how the market works in our wired and intensely short term focused era, and they are reassuring to hear. If that's the mentality driving the market, it will pass.

These rambling thoughts may congeal into something more coherent soon, the sooner the better from this perspective. Memories of late 2008 and early 2009 are too fresh to promote restful sleep.


Anonymous kf said...

At this moment, there is no catalyst to buy equities. The weathier tier of consumers cannot continue carrying the spending load forever and the broader consumer segment is stalled out by housing issues, gas prices, and jobs that offer little prospect of salary growth. In fact most jobs today offer negative inflation adjusted real salary "growth".

What's an investor to do. Play safe and keep some assets on the sidelines. Don't expect anything in the near future to get better.

So we're in for a season of losses or boredom or both. Someone wake me up when this turns around and I'll jump back in with both feet. Until then, sweet dreams.


Give me a call sometime. I'm still down here on the LES, trying to keep my little fund going. Let's talk.

3:30 PM  

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