The Stock Market – Can You Trust It?

 

Can you trust the stock market when it moves too far too fast as in 2009? The challenge of stock investing is being able to sense the change of tide before your stocks are swept out to sea. Keep an eye out for the curious and unusual. Sometimes a bull market has no legs and runs out of steam.

So, the stock market advances over 50% in a matter of months as a recession seems to be headed for history. Can a bull market like this have legs and keep going? Usually a bull market starts before an economic recovery is a certainty, as in 2009. Experienced investors buy stocks because they know the game. Then others join in for fear of missing the market.

There is only one thing you can safely bet on in stock investing under such circumstances. If the recovery does not unfold and grow wings, a bear market and falling stock prices is likely to follow. If, that is, a recession was what sent prices down before they went up too far too fast. Sometimes it’s not that simple. For example, in the early 1930’s and in 2009. In both cases a brutal bear market resulted from a financial crisis.

When the financial system is threatened, all bets are off. If the problems that caused the crisis are not addressed, they can come home to roost again. That’s why I kept an eye open for the unusual as stocks soared in 2009. For that bull market to have legs two things needed to unfold in 2010: a growing economy and confidence that the financial system had been fixed.

If investors were confident that the financial mess Wall Street created was cleaned up, why were gold prices at all-time highs in late 2009? Why did the stock market react positively when oil prices went up and the dollar fell? Even with interest rates at historical lows, real estate was still in the pits. People were walking away from their mortgages in record numbers because they were under water. The unemployment rate topped 10%, and the consumer was afraid to spend money.

None of the above is normal for an economy on the mend. Wall Street was still into financial leverage, and was infested with complicated derivatives. These were the powder keg that launched the financial crisis. Was that powder keg defused?

Successful stock investing requires that you watch the tide and don’t just go with the flow. When really bad news hits a bull market that has gone too far too fast, that spells trouble for investors. Even a bad shopping season can be enough to send those who jumped on the band wagon to the sidelines. Don’t trust a stock market whose behavior is not justified by economic or financial fundamentals.

Keep one eye on the market, but keep the other searching for a reason to justify its price action. When things don’t add up, lighten up in the stock market.

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