Stack blocks into a tower and there comes a point at which you know the whole thing is going to collapse.
You don’t even have to be trying to make the tower taller. You might simply breathe wrong or the floor might shake, but you just know that a collapse is imminent.
It’s the same kind of feeling a lot of people have had with the stock market at certain points over the last few years, and certainly during the last month.
Just a few weeks ago, the stock market was in the throes of a mini-correction, a short, sharp downturn that temporarily put the Dow Jones industrial average below 10,000 and seemed to have everyone fearing the worst. And this free fall was happening in October, the month during which many people have come to expect market reversals in general.
But nothing happened.
So here we are, at the end of November, with the end of the year beginning to take shape, and the market still hasn’t collapsed, despite the fact that it looks to many people like a wobbly tower of blocks.
That said, it’s a good time to consider what it would take for the market to implode. There are possible triggers, but none appears immediately on the horizon.
Ask most experts what could derail the market and you get some combination of three enormous factors: interest rates, earnings expectations and economic growth.
A sharp increase in interest rates, a slowdown in corporate earnings (or a growing number of “earnings surprises”) and reduced economic growth all could trigger a market downturn. While each factor could do it individually, the truth is that all are related.
– Interest rates. At the last Federal Reserve meeting, on Nov. 16, the Fed raised short-term interest rates but not enough to rattle anyone, boosting them by just a quarter of a percentage point.
“The Fed would need to do something much bigger, a more drastic move, in order to send a message that `The party’s over and we’re taking away the punch bowl,’ ” says James Stack of Investech Research in Whitefish, Mont. “That kind of larger move could cause a bear market.”
Stack and others note that the stock market crash of 1929 and the long-running market problems of Japan both started when the central bank made a large hike in interest rates after a series of short ones.
That didn’t happen.
– Earnings. Having just lived through a period when quarterly earnings came out, the truth is that earnings problems are not likely to become a market force again until January.
That said, however, it is tough to tell whether Wall Street values actual earnings growth as much as it does having earnings that conform to analyst expectations. In many instances, it seems the corporate goal is not so much to increase profits as it is to keep the analysts happy. (Witness any number of Internet stocks that are valued more on their potential and the fact that their losses were “smaller than expected” rather than on the basis of reporting profits.)
That phenomenon doesn’t strike me as completely rational, but it does create more possibilities for market problems, in that a few companies announcing a likely earnings shortfall near year’s end could send entire market sectors into a tailspin.
“String the right kind of disappointments together one after the other, from the big tech companies and Internet stocks, and you will see people lose faith in almost everything,” says Mark Riepe, director of the Schwab Center for Investment Research. “Earnings, or earnings surprises, are driving a lot of the market, and a change in earnings could change everything.”
– Economic growth. This, of course, is the big picture that brings you back around to the first two factors.
If employment costs rise or if inflation creeps back in or if gross domestic product grows more slowly than expected, you have the makings of a market meltdown. The question is whether the big economic factors will trigger interest rate increases and reduced earnings growth, or whether rates and earnings will bring the economy down.
– Y2K fears. The fears themselves aren’t likely to blow up the market. Wall Street seems to believe the millennium bug is not going to be a big deal and has factored out the possibility of major computer meltdowns at the beginning of the year 2000.
That said, if Y2K becomes a bigger problem than most people now seem to believe it will be, it could shake things up.
– Investor confidence. Having stocks that are overvalued doesn’t cause a bear market. The end of any period of market exuberance comes when investors realize that it’s last call and the bar has closed.
That doesn’t happen by itself; you’ll need a strong move by the Fed or a dramatic decline in earnings to shake the confidence of investors.
So when you look at all of those factors, you don’t see any obvious detonation point for the current market. Yet, countless people tell me they are nervous about current market conditions, that they have a bad feeling about what’s going to happen next.
And therein lies the big question for investors: What to do in these uncertain market times?
Truth be told, all market times are uncertain, so the answer to this question almost never changes. Keep your short-term money out of the market, even though there is no flashpoint likely to cause a short-term blowup, and keep your longer-term funds fully invested and diversified, hoping to ride out any problems that come up.
You can find market predictions out there from reputable folks calling for the Dow to hit 6,000, 12,000 or 36,000.
Chances are the best thing the average investor can do is ignore all of those prognostications and stay the course.
The immediate short-term period looks pretty good, the long-term picture looks pretty good, and in between you can expect enough volatility to make you nervous, but not so much as to stop you from reaching your goals, provided you have a sound financial plan.
