Sentiment and Reality

Shakespeare’s Hamlet observed that nothing is good or bad, but thinking makes it so. He certainly wasn’t talking about the stock market, but his commentary fits the market’s dizzying ups and downs some 450 years later. How else can we explain a market that ended the third week of October showing an 11 percent bounceback (since its Oct. 3 low), only to post losses that wiped out all the gains just three days later? Volatility like this suggests an investment community that wants to embrace good news but is fearful of other major factors – notably the European debt crisis. Here’s a synopsis of some of the current talking points.

Volatility

It’s not just your imagination. We are seeing big swings in investor sentiment repeated frequently. The Dow Jones Industrial Average has moved more than 1 percent daily for 43 days since June 30. We have to look back to the dark days of 2008 when the U.S. financial crisis was at its lowest point to match this degree of volatility. Market rallies have been short-lived in the face of global economic issues. In scenarios like this, perspective is a rare commodity and bad news makes yesterday’s good news history.  

Europe and the World

The Italian government’s impasse is the most recent challenge to a decisive solution to European debt problems. Without Italy’s agreement to the economic measures EU officials require, negotiation leaders were unable to move forward with their grand plan (although an agreement on Greek debt was reached Oct. 27, sending world markets higher). Italy’s growing debt is second only to Greece’s, and the country’s fate is integral to the entire Eurozone because it represents the zone’s third largest economy. Some economists think that a recession in Europe is likely, and that the best-case scenario involves reduced government spending and weak economic growth. These issues also cast a shadow over China’s economy. However, analysts expect the global spotlight to return to the United States as Congress faces a deadline of Nov. 23 to unveil its spending cuts.

Domestic Factors

The impasse in European negotiations coincided with some recent disappointing corporate earnings in the United States and a decline in the Conference Board’s index used to measure consumer confidence. These factors were the major cause of the sell-off that hit the Dow on Oct. 25. In the midst of such bearish sentiment, some analysts have been quick to remind us that if successful investing followed a predictable pattern, we would all be wealthy.

Contrarian Wisdom

Can pessimism be a good thing for individual investors? History indicates that consensus can be wrong. Advisors urge investors to be cautious about following current consensus views and also to be leery of safe bets. Risk is part of the game. Data can be misleading – especially sentiment indicators that often belie how consumers will really behave. Contrarians sometimes regard a general mood of pessimism as a possible indicator that a market bottom is on the horizon. They point out that there is often a gap between sentiment and market performance. Positive economic news includes data showing increases in spending for consumer staples and an uptick in retail spending. Contrarians are realists though – they don’t believe that market volatility is likely to be over very soon.

As always, the observations made in this article are general comments and are not intended to replace advice from investment and tax professionals.

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