Name: Email:

Where Do YOU Think the Stock Market is Headed?

The stock markets’ recent 1,000 point slide is a good time to stop and ask some critical questions

By Kevin M

Let’s get one thing out of the way right up front: I am NOT an investment expert!

Now that that’s been declared for the record, let’s mush on.

After bottoming at 6600 in March of 2009, then rocketing to the 11,000 level in just over one year, the Dow Jones Industrial Average has given up 1,000 points in a space of only a few weeks. What does that mean? Does it mean anything at all? It seems we may be at a crossroads.

There are two schools of thought on where the stock market is heading, and the implications of either are of no small consequence where our personal finances are concerned. If we firmly believe the market will rise, we need to position ourselves for maximum gain when it does. If we think it will slide—or even crash—it’s incumbent upon us to arrange our assets in such a way as to minimize or even eliminate losses.

Are we about to break out of the 10,000 level on the Dow, and if so, which way is it more likely to swing?

The optimistic view

The higher Dow position isn’t hard to find in the news these days. Some of the common arguments supporting this view include:

  • The housing and mortgage meltdowns seem to have hit bottom.
  • Interest rates are at all time lows.
  • Gross domestic product (GDP) is growing.
  • The unemployment rate, though still hovering around 10%, has stabilized.
  • The bank panic has subsided.
  • Corporate profits are on the upswing.
  • The dollar is showing strength, especially against the Euro.
  • Even with the recent slide, the market is still up 50% over its 2009 bottom.
  • The business cycle appears to be moving from recession to growth.

If the business cycle is alive and well, it’s clear we’ve turned a page in the past couple of quarters, and predictions of a higher market are well within the realm of credibility.

The pessimistic view

It would be tempting to discount entirely the possibility of a crash, relegating it to the realm of manufactured hysteria, except for the reality that it’s happened twice in the past ten years.

An article this week appearing on Yahoo! Finance provides a summary of the pessimist’s view of where the markets are heading in Warning: Crash Dead Ahead. Sell. Get Liquid. Now. (MarketWatch, 5/25/2010) that lists compelling reasons why the markets are headed for their third crash in the very young new millennium, including:

  • The financial system remains unstable, and measures taken to date have fixed nothing.
  • Government debt is increasing to unsustainable levels, locally and globally.
  • There’s still a substantial amount of excess, high risk debt.
  • Despite statistical improvement, the real economy remains fundamentally weak.
  • Another shock could tip the apple cart—confidence in the system is near the verge of collapse.

Other reasons are given, and curiously it doesn’t mention the European financial crisis that now seems to be coming to a head.

The tone of the article calls not for a correction or even a prolonged bear market, but a full blown crash, worse than anything experienced thus far and leading to major problems that will move well beyond Wall Street.

Forget the experts—what do you think?

For a moment, let’s forget about what the “experts” think and say; after all, no one has a crystal ball. So, what do you think will happen?

Here are some questions to get you started…

1. Which way do you think the market is headed?

2. Where do you think it will be one year from now?

3. Given all of the admittedly bad news in the background, what do you think will drive the market higher?

4. What percentage of a person’s portfolio do you believe should be in stocks right now?

5. What sectors do you think will do especially well? Which do you think should be avoided?

6. Do you think the 21st Century’s Crash No. 3 is imminent?

7. If you believe the markets are heading down in a major way, where should we be putting our money now?

8. Given that it’s happened twice in the past ten years, is it possible that stock market crashes have become the “new normal”?

Pick any question or group of questions you feel qualified to answer or, if you feel really ambitious, tackle them all. This is an exchange of ideas, so there are no right or wrong answers here.

Also check out this related post by John D. Buerger, CFP, Flash Crash. But be sure to come back and weigh in with your comments!

( Photo courtesy of auburnxc )


28 Responses to Where Do YOU Think the Stock Market is Headed?

  1. Kevin – you’re right, no one has a crystal ball. We don’t know what’s ahead. I would just add a third view – the cautious or realist view, which would include lowering expectations, diversifying your accounts and being “nimble” enough to navigate through these choppy waters.

    As far as percentage of stocks etc, that always depends on age, risk tolerance, goals, time frame etc. Every one is different.

    If you are close to your retirement goal, it’s probably a great time to shore up what you have and get a little more liquid, perhaps look for some income opportunities and stop trying to “shoot the moon!”

  2. Kevin M says:

    So, so much for invest-and-forget!

  3. MoneyEnergy says:

    Well, you know what I think. This is the classic watercooler topic for investors – always timely!:) I think we’ll see another rally now that this one has bottomed… but we might hang out on this bottom until the beginning of June, though…. I’m really looking forward to Canada raising interest rates ahead of the Fed. That should give a shot of adrenaline to the loonie which will be nice, again.

  4. Kevin M says:

    MoneyEnergy – it sounds like you’re lined up on the optimistic side…

  5. The investment world is riddled with the carcasses of people who tried to guess which way the market was going to move next. I would suggest that the smartest investor is able to make money no matter what the market does. I also suggest that the current price on the Dow or S&P relative to history is worthless data – what matters is fundamental value in the long run.

    From an economic standpoint, there are a lot of major global headwinds, most significant being the sovereign debt issues in Europe, China and the US. Can they be resolved without a calamitous drop in US equity prices? Sure. Is it likely? No. Then again, the market can remain irrational much longer than most of us can remain solvent.

    There ARE ways to insulate your downside and even profit from a turbulent market. These include safe derivative strategies (futures and options for example), insurance products like annuities or even Forex plays. The person who limits your choices to only “stocks” or “bonds” is painting you into an ugly corner … a corner where they make money on the transaction and you are left holding an empty bag.

    As far as equities go … the markets are fundamentally over valued. This means that if you invest today, the probability is very high that over the next 10 or even 20 years, you will earn a low rate of return (3-5%) BEFORE inflation. That would seem like a loser’s play. Then again, bonds are destined to drop in price (and significantly so) as interest rates have nowhere to go but up over the next several years. Alternative asset classes may be the only alternative … or holding cash until valuations become more reasonable.

    No matter what … have a strategy and stick to it. Don’t play the emotional investor game. You’ll pay dearly. Even a simple strategy when executed consistently will beat any of the alternatives.

  6. Kevin M says:

    John – Your comment “the market can remain irrational much longer than most of us can remain solvent” is intriguing. I’ve long believed it has more to do with market behavior then we like to admit.

    On both the upside and downside, markets seem to carry much further than anyone ever thinks they can or should, but the net affect is the same. It all seems to argue for basic conservatism.

    Do you think the average person has any understanding of the type of plays you suggest to cope with the wild swings?

    FYI – John has more to say on this on his excellent post Flash Crash. Be sure to check it out.

  7. Len Penzo says:

    If the market was rational, it should be headed down. But it’s not.

    Most of the “good” news is thanks to the massive government spending and temporary tax breaks for housing. Considering all the stimulus money that the government has pumped into the economy, the GDP numbers are not impressive at all – and that money is essentially spent.

    The Bush tax cuts are expiring and new taxes are coming into play to pay for this country’s crazy foray into socialized medicine.

    This administration plans on running *trillion* dollar annual deficits through 2018 and our debt to GDP ratio will be over 100% in the very near future.

    The National Debt is currently $14 trillion, but our unfunded liabilities were $109 trillion (and that was BEFORE the Dems pushed through Obamacare).

    As a father of two young children, I am fighting mad about all of this. A lot of the pain is going to be on them in the form of a greatly reduced standard of living.

    The only way out of this mess is probably a massive devaluation of the dollar via high inflation.

    Other than that, the US economic engine is purring like a kitten. LOL

    Best,

    Len
    Len Penzo dot Com

  8. Kevin M says:

    Len, you’re highlighting the obvious disconnect between the markets and Main Street/Reality on the other.

    We can’t forget that stocks continued to rise, then set another all time high in October of 2007, two months AFTER the mortgage meltdown had officially begun.

    That alone should make us all cautious.

  9. Good comments – I’d have to agree with the rational/irrational argument. Basically the markets are driven by fear and greed. I’m amazed at how many people last year wanted to get more aggressive because they were making more money and then as soon as things start to shift they panic.

    John makes a great point about making money no matter which way the markets headed – that’s the idea.

  10. JoeTaxpayer says:

    I think that no one can pick the bottoms or tops, but given the prior ten years, we have a bit of catching up to do to catch up to the longer term trends. Remember, very long term is closer to 10%, expecting 10% from where we are now isn’t too unreasonable. My personal hope is for 6-8% min.

    As far as current events. It’s noise. A mess we will get out of.

  11. Kevin M says:

    Jason – I think fear and greed will always dominate the financial markets. We need to think and invest long term, but emotions may put a limit on how well we can do that.

    JoeTaxpayer – You have a very calming, very reassuring tone.

  12. now that obama and the feds are tinkering with it, that can’t be good. More federal rules and regulation is bad news for us all.

    My personal view. Of course I could be wrong.

  13. Kevin M says:

    Some people think that more regulation is the answer. I wonder if it hasn’t gotten so complicated that even that won’t make a difference.

    Speaking of complicated, has anyone noticed that we don’t hear anything about derivatives anymore???

  14. Aury (Thunderdrake) says:

    I’m pretty much preparing myself for a stock market crash to come about yet again. I’ve been very pessimistic on the western economy as a whole.

    In other words.. I’m a bear.

    Though that’s not to say I advise anyone getting into the stock market. On the contrary. There’s more money to be made if you know how to play like a bear!

    But I’ve always prepared for the worst. I never count on capital gains, hawk on bearish environments, and focus primarily on those dividend checks.

  15. Interestingly enough, I think I can remain solvent much longer than the market can remain irrational. After all, the market consists of people who need to spend money to live. And they seem to need to spend more money than I, so therefore …

  16. Kevin M says:

    Aury – You’re in the bear camp at least, and open to the possibility of another crash.

    What strategies are you using to capitalize on a down market???

    Early Retirement – Good point. It all comes down to individual strategy–the markets will always do what the markets do.

  17. What direction is the stock market going to take from here? Many financial analysts can’t even agree on where it has been or, more importantly, why.

    In asking the question of which direction the stock market will take from here we ask, “In relationship to what?” If we measure the output of the stock market in U.S. dollars, we will be continually deceived. We have to learn to measure the stock market output in terms of other assets. Ratio charts are very helpful in this regards. These charts measure output in terms of other assets rather than currency. In a world of floating exchange rates and the massive printing of currency, on a global basis, it is increasingly important to learn to value tangible “things” in terms of other tangible “things.” Currency is a very illusory measuring stick. What we want to know is how many sets of tires, tubes of toothpaste, rolls of toilet paper, gallons of milk, pounds of butter, ounces of gold, ounces of silver, or months of rent the DOW is worth.

    During the Weimar experience, Germany’s economic output was seriously impaired while their stock market was rocketing to the moon. Obviously, the stock market can rise significantly during severe declines in economic activity. But in this case, we ask in terms of what? It was in currency terms only that the German stock market was rising. By every other measurement, the stock market was tanking. The German currency was being used as a substitute for firewood and burned in wood stoves.

    What we see going on in Europe began here and will end here. Quantitative easing (a sophisticated term for spending yourself out of debt) is the sought after solution for the dilemma we find ourselves in globally. Spain has already lined up behind Greece for the next bailout. After this crisis moves from Europe and on to Britain, it will come after the U.S. dollar with a vengeance. Each individual state, beginning with California, will line up for their bailout. The dollar is doomed. So if we use the U.S. dollar as a measuring stick for determining the value of something else…we will no doubt wind up on the short end of the stick.

  18. Kevin M says:

    That’s exactly what Charles Hugh Smith (link in left column under Blogroll) has been writing about for years.

    In the early 1970s, an ounce of gold went for about $35 while the Dow traded at around 1000, so it took about 30 oz of gold to “buy the Dow”. Today with the Dow at around 10,000 and gold at $1200, it takes only 8 oz of gold to buy the Dow. Same with oil. It was about $3 a barrel in the early 70s, so it took about 330 barrels to buy the Dow. With oil at about $75 today, it takes only about 130 barrels to buy it. The Dow is down against gold and oil, even if it’s risen by a factor of 10 in purely dollar terms.

    I think there’s a lot to this.

    The problem/complication with that is that when we measure the stock market, we do it in dollars, and when we compare returns, we do it with other financial instruments–typically interest bearing–that are similarly priced in dollar terms.

  19. Kevin,

    Thanks for mentioning the link to Charles Smith. When we took a peak at the link, we also noticed the Daily Java forum…looks interesting…we’ll explore more there.

  20. Hard to say. Probably nowhere frankly. Although I worry Euro zone will be more like the US, and hit us for 18 months. Then it’s a 20% decline.

  21. DIY Investor says:

    Guessing the direction of the market is a fool’s game. It gets you caught up in the emotion cycle that devastates individual investor returns. Instead concentrate on coming up with a good asset allocation depending on your risk tolerance, investment horizon etc. Then execute that asset allocation with low cost, index funds and pray for the market to drop. You will be taking advantage of the process known as dollar cost averaging. In the long run you will have a portfolio that grows substantively.

  22. Kevin M says:

    DIY – those are all excellent suggestions for thinking and working as a long term investor. Since most of us aren’t stock market experts, and don’t have the emotional make up to be traders, we have to work toward patient capital. That means strong fundamentals, cash flow and buying when prices are down.

  23. Matt says:

    To quote Woody Allen:
    “Today we are at a crossroads. One road leads to hopelessness and despair; the other, to total extinction. Let us pray we choose wisely.”

  24. Kevin M says:

    I was never a big Woody Allen fan… I suddenly remember why…

  25. While it is not easy to predict the direction of the stock market in the short term – because of how irrational most investors are – it is possible to look at potential real return in the intermediate and long terms.

    I believe that we are in the middle of a prolonged bear market that may last until 2018 (or longer depending on what our current government does)! Also, as mentioned by Len Penzo, since stocks are severely overbought right now, the chances of earning a real return of more than 1% is not too promising in the next 10 years!

    Of course there is always other opportunities for higher returns (options, mixed funds, individual stocks), but it will take more than buying a long only index fund.

  26. Kevin M says:

    I’d have to agree that the future of the market looks dicey. It’s a strong argument in favor of some conservative approaches. I’m guessing that the future will require investors to have a strong stomach.

  27. Wayne Robinson says:

    I don’t believe anybody *really* knows the answer to this question for themselves until they understand exactly what their own risk tolerance is, and how that tolerance relates to what they’re trying to accomplish with the money they have to invest.

    By many meaningful historical measurements US stocks are overvalued right now though. For example, the Wilshire 5000 (a fairly good representation of the entire US market) is trading at 23 times earnings. The dividend yield is under 2%. Nobody knows what’s going to happen in the markets tomorrow or 5 years from now, but we can use historical values to find clues about how expensive or cheap the markets are today. And they’re pretty expensive right now.

    If you’re investing passively (401k, etc.), and your time horizon is long-term I believe you should stick to an asset allocation model that includes US stocks. But I wouldn’t encourage anybody to be overweight in a broad US index fund right now.

  28. Kevin M says:

    That’s kind of my feeling too Wayne. The market is way up after a long slide and is sending mixed signals. That looks like a yellow caution light to me. Still, I think there needs to be some money in stocks in case the chaos produces a 5000 point run. It’s not at all out of the question.

Leave a reply