What Not to Worry About
By Bob Landaas
It’s not the known risk that you worry about. It’s the unknown risk.
When you look at what has taken down the markets in the last 35 years, the majority of the instances were total surprises.
- 911. That Tuesday morning, no one was predicting those attacks.
- The Persian Gulf crisis of August 1990. Our own CIA didn’t foresee Saddam Hussein marching into Kuwait City.
- The stock market crash in October 1987. No one called that.
- The Arab Oil Embargo. That saw oil quadruple in price in the mid-1970s, creating the worst recession since the Depression – at that time. No one forecast that either.
I’m always amazed how people worry about the wrong things.
Worry about the unexpected, not the known risks. Typically, the known risks are factored into the financial markets.
If there’s a strong risk that inflation’s going to rise, it’s already reflected in the bond market. If there’s a risk that earnings are going to decelerate, the stock market already reflects it. It’s the known risk that you try to work with.
As an example, the fiscal cliff – the Taxmageddon that mandates a 4% reduction in government spending along with the expiration of the Bush tax cuts – is a known commodity.
Everyone knows that it will potentially push us into recession. Everyone knows that it’s an act of Congress unless Congress overrides it. Everyone knows that it’s unlikely to get resolved until after the election.
And yet, what’s not being priced into the markets is the very real possibility of a compromise and a resolution of the issues. That argues for an upside surprise.
The same is true to a certain extent with the European debt crisis. We’ve known for two years that the banks and the governments in Europe are struggling. We know that it’s a solvable problem. They’re just pushing and shoving over who’s going to pay for it all. But until it gets resolved, the markets are going to act like it hasn’t been resolved. So it too has the possibility to surprise on the upside.
The elections would be viewed the same way. I’m positive that someone’s going to get elected to be the next president of the United States. I’m also positive that people have deferred making financial commitments and companies have deferred spending, pending the outcome of the election.
Historically, the certainty that gets delivered after the election helps to remove yet one more variable in the equation. Living in a period of permanent uncertainty, it’s always helpful when you remove one more variable.
One of my favorite sayings is that the market climbs a wall of worry.
That’s certainly what we’ve seen this summer. The stock market went up for six weeks in a row at a time when most of the news was negative. That’s normally how markets trade. By the time the news is terrific, equity prices have already gone up.
This is the time of year when it’s critical for investors to remember that interest rates and earnings are the only two factors that cause stock prices to go up or down longer term.
During the election season this fall, we will be overwhelmed with peripheral noise, making it crucial to focus on the fundamentals of interest rates and earnings.
The Federal Reserve has made it clear that it does not intend to raise interest rates until 2015, at the earliest. It’s very unusual that we get two years or more in which to anticipate stable rates. As you know, steady or declining interest rates make stocks more attractive.
We’re still on pace to set record profits for the S&P 500 by yearend. And the analysts anticipate establishing new highs for earnings again next year.
Once we get past the near-term “uncertainties” of the euro crisis and the elections and the fiscal cliff, the outlook for the markets is promising.
Bob Landaas is president of Landaas & Company.
initially posted Aug. 30, 2012