For many years now, "March Madness" has been the term affectionately used by basketball enthusiasts to refer to the NCAA's national college basketball tournament played every March. As such, it has come to connote wild fervor, chaos, determination and uncertainty. And as such it's a term that can also be used to describe the investor activity we've witnessed in the U.S. stock markets recently.
The world was nowhere shaken as badly by the events of 9/11, as it was in the financial centers, and especially in the New York Stock Exchange. For weeks and several months, no one knew what was going on with our economy. And now, congruent with many of the most respected predictions of last year, the economy, and along with it, the stock market seems to be showing promising signs of prosperity. But before we get overconfident, and rest upon our expectations rather than the principles of sound investing, let's take a step back and review the basics.
Let's ask the most unasked and most obvious question: "Why invest?" If you said, "To make money" you are without a doubt correct. But let's take a little more detailed and analytical look.
Technically speaking, a stock's current market price should equal today's value of all of the future income the company is expected to earn. It is an age-old financial concept known as discounted cash flow analysis. This concept is based on the fact that a rational investor should ask, "what am I willing to pay today for all of the future income I will receive over the time I own this stock?" If you believe that, in fact, current prices in the marketplace represent expectations about future corporate profits, as you witness the wide gaps between the highs and lows of a great many stock, you might be asking, "What does the current immense volatility suggest?"
The big swings in stock prices likely indicate two things. First, investors are seeing prices move in response to mixed macroeconomic data. On the one hand, the Fed's leaders such as Chairman Alan Greenspan and Dallas Fed President and fellow FOMC voting member Bob McTeer, along with many others, are trumpeting the strength of the economy and even suggest that inflation could be just around the corner. They point out that the economy may not be in a recession even today. On the other hand, raw data from other sources paints a much darker picture. Unemployment continues to rise and threatens economic recovery. Surveys of corporate management show persistent concerns that IT spending is not likely to bounce back anytime soon. What is there to say these mixed responses? Well, if you feed a system mixed data inputs, you will get mixed data outputs. It's that simple.
Second, Wall Street analysts are behaving less like lemmings than in recent years, which, taken on the whole, is evidence of significant progress. However, this has presented a bit of a new problem. Some analysts are actually conjuring up original ideas and investment themes (not to be too cynical, but this is an historical event). But what happens is that, independent thinking among market-influencing analysts leads to bull and bear perspectives clashing on the trading floor. One day the bulls overpower the bears, the next day the bears win the battle. All the dogs are not pulling the sled in the same direction and it produces a situation which is unpredictable.
But, lest we despair, we should say that while all of the recent volatility may seem like a bad sign, it is likely a harbinger of positive things in the near future. For one thing, it means that investors are paying closer attention. They are not as passive as they have been in the past and are more sophisticated. This keeps the brokers and analysts on their toes and tends to reduce the sway of emotions on the market. And some of the dramatic sell-offs of recent days also suggest that there exists a healthy amount of skepticism about the recovery. It appears that genuine pessimism and general gloom has come over the market during closing days of the first quarter. Remember that markets never go up until the majority of investors turn negative. This is known as "climbing the wall of worry."
Again, the recent volatility and worry really seems to be a healthy sign of the market finally turning the corner.
Overall, investors were treated to gains in March. Those gains were significant enough that the sell-off at the end of last month was not enough to erase the big early-month rallies. This could likely be a pattern for months to come. Several big-gain days followed by easing back on lighter trading volume could be the norm for a while, at least until the economic data starts to get lop-sided either the bears or the bulls dominate have a winning streak (we're rooting for the bulls).
It seems that the more theoretical prognosticating that's thrown at the situation, the worse it becomes. Perhaps if we can piece together several months of improving data, the doubting Thomases may loosen their purse strings and get their cash back to work. Then again, maybe it's best just to take the attitude similar to the man who was asked if he thought it would rain. He replied simply, "Eventually."