Rational Investing: Wall Street analogy shifts from roller coaster to bouncy ball

One obvious sign is the number of research reports published, especially during the week preceding the Labor Day weekend. Not only is the quantity of research lower than anytime of the year except Christmas, but the trading volume on the exchanges also declines.

Those are reasons to distrust significant market moves, either up or down, when they occur on light volume. And should a large price change occur on large volume, don’t assume it is a valid indication of the market continuing to move in that direction; see how it behaves in terms of direction and volume in the days following.

From our most recent letter to clients:

“Those of us of a certain age may recall the sing-along at the movies that asked us to ‘follow the bouncing ball.’ I always tried my best to follow the ball enthusiastically, unfortunately while singing out of tune – flat – to the distraction, I imagine, of those sitting in my vicinity.

“What caused me to recall those days of 35-cent theater tickets? It is the analogy of the bouncing ball to the gyrations of the markets. Bounce up – come down – bounce up – come down. The old analogy of the roller coaster just doesn’t apply any longer. It has a degree of certainty, as a roller coaster always returns to its starting point.

“So the question is, ‘When does the bouncing stop?’ And the answer is (may I have the envelope, please?) nobody knows. However, there are several reference points that could pave the way to the markets’ displaying more consistent behavior:

• The treasury, in concert with the Federal Reserve, removing the uncertainty about how they are going to solve the Fannie Mae and Freddie Mac capitalization crisis and the financial industries’ liquidity problems.

• Congress and the White House agreeing on an energy policy, ideally one that does not penalize corporate America or the individual.

• Investors expressing a degree of comfort with the tax code effect of the November elections and the impact on the markets.

• Expectations of improving corporate earning in the coming year. (The markets’ discounting mechanisms normally start anticipating earnings six to nine months before they are reported.)”

Toss in the unpredictability of geopolitical events (think Russia, Iran, North Korea, Venezuela, etc.) that are unlikely to go away in our lifetime, and you have an outlook for continued volatility for several months.

Of course, politics continue to grab headlines, as the media dig for dirt on anyone running for office, hoping to get an investigative exclusive. (Oh, what Woodward and Bernstein started!) Substantive proposals for, and debate about, the major issues are likely to be supplanted by candidates’ pandering with give-away proposals and emotional issues.

The political prattle continues, engendering wishes that there could be a limit on the number of months – or even days – during which candidates could actively campaign. It’s bad enough that irrelevant issues are brought up, but topping that nonsense are the ad hominem attacks.

Diversification and careful selection of issues remain keys to waiting out the bouncing ball period, but then they always have been keys to successful investing.

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.[[In-content Ad]]