Opinion: Bull market, Fed chair bring volatile behavior

And why not? It is irrational behavior, just as irrational as the first half of the year’s steady decline in the prices of the stocks of many, many financially strong, well-run companies. But more on that in a minute.

In a letter to our clients in early June, I discussed the behavior of the markets resulting from interest rate concerns:

“In my lifetime, there have been eight Federal Reserve chairmen; six during the years I have been in the investment business. I can faintly recall the market angst when (Alan) Greenspan took the helm but remember little about the early months of his predecessors’ terms.

“My lack of knowledge about what did or didn’t roil the markets in the first few months of the earlier Fed chairmen’s reigns could be attributed to shoddy memory or plain disinterest at the time, or the fact that the media, in an era of much slower and less frenetic communications, simply did not put a lot of emphasis on the role of the chairman.

“Not so with the media now, as every appearance, every utterance, by Chairman (Ben) Bernanke is jumped on. He is learning that off-the-cuff comments about the economy – and interest rates in particular – can impact markets. It is the same lesson that Greenspan learned after an ill-advised interview on TV.

“Now the focus is on Bernanke, inflation, and interest rates, with the ‘stagflation’ word rearing its head. (Wonder what I did with that old Whip Inflation Now button?)

“Until market participants feel more comfortable with Bernanke’s handling of interest rates and have come to understand better the content of his comments, we expect volatility will continue.

“Putting volatility into historic perspective in terms of market declines within the framework of a bull market reveals that in every bull market since 1970 multiple corrections of 10 percent or more have occurred, with multiple double-digit declines taking place during the bull markets of 1974–1980 and 1990–2000.

“Those are the type of declines that chase weak money from the markets, providing serious investors potentially rewarding opportunities.”

So what caused a squeamish market to rocket upward more than 200 points when the Fed announced a quarter-point rate increase at the June 29 meeting?

Check that letter above, and then apply the message to the Federal Reserve’s comment that, “... economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.”

For a market hungry for good news, “the end of the interest-rate hikes” was all that was needed to touch off a buying spree, as investors chose to interpret that statement to mean that the end is here or at least very near for increasing interest rates.

Had anything changed in terms of individual businesses’ earnings or sales or balance sheets or any other fundamental investment factor? Nope, the change was basically one going from a negative to a positive psychology at the same time that mutual funds and institutions were wrapping up their midyear window dressing. So all of a sudden, all was sunny and bright.

Don’t get me wrong: I’m not implying that the market won’t do well over the remainder of the year (although I am more interested in the fortunes of individual companies than in the “market”).

I am simply suggesting that irrational behavior does not live a long life, and that one day does not a trend make.

Of greater interest to me are the facts that this year mergers and acquisitions are taking place at a rate greater than any I have seen in the past, corporate coffers are loaded with an incredible amount of cash, and stock buybacks are rapidly being established or increased. This tells me that the true “insiders” (the legal ones, not the Enron or WorldCom types) who know better than anyone on Wall Street what their individual companies and competitors’ companies are worth, see greater value in corporate America than has been reflected in the market prices attached to many companies stocks.

The lesson in this is one that we all must learn as we go through our investment education: Stick with the basics, don’t ignore what the informed investors are doing, and avoid the daily noise.

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.