Nothing to Fear but Absence of Fear

07/06/2009 3:43 pm EST


Jim Lowell

Partner & Chief Investment Officer, Adviser Investments

Jim Lowell, editor of Fidelity Investor, warns that a complacent market could soon stumble despite the glimmers of hope for the economy.

As we put June behind us, we also put the best quarter for most major markets at home and abroad in over a decade (and the best rally since the great Depression.)

In June, after reaching it lowest levels since the September ’08 blowup, the VIX remains… a far cry from normal fear levels and decidedly removed from its panic peak. While not reflective of complacency, [it suggests] that there’s not enough fear [factored] into current market prices.

Last month [did begin] to unveil a shift from risk trades to risk aversion trades—not by bailing out of stocks and into bonds at any price, but from more ‘growthy’ types of stocks to more defensive ones. Healthcare was the bellwether beneficiary of this shift. But the overall market was as well: investors are looking for value in the valleys rather than running for the hills.

Another shift: the World Bank revised its estimates of global contraction lower; suggesting the global economy will shrink 2.9% vs. their earlier estimate of a decline of 1.7%, and further suggesting that recovery will be one of slower growth than prior recoveries. I think this news is priced into the markets at home and abroad. Our Fed concurs.

The Fed’s non-rate hike move, and more notable removal of its prior statement about deflation, didn’t challenge the broad assumption that the worst is behind us. Overall, the economic reports continue to present us with a patchwork quilt of relatively comforting news about the decline of the pace of the decline, but that doesn’t mean the markets won’t retest the advance of the prior months in the coming ones.

Key to the [likelihood] and scale of that retest will be July’s economic and second-quarter earnings reports. …It’s not too early to suggest that there is so much priced-in optimism about a floor having been set and stabilization having been achieved, that there’s some room for disappointment to upset the recent rally’s cart.

That’s not the same thing as saying the cart will be upset. After all, we’ve seen nothing but evidence in support of the priced-in optimism whether it’s in unemployment, GDP, durable goods, or even car sales. Still, with the assumption of a steadfast pace of winnowing decline (and the latent assumption of pending growth) baked into this market's global cake, it only makes sense to question what might blow out a candle of enthusiasm or two.

Not that blowing out a candle or two would leave us bereft of what looks like a sustainable belief in recovery. And that belief, as it relates to confidence in terms of spending and investing, is essential to any recovery. And so, against a rational expectation for a test of the fundamentals supporting the recent rally, we have an inbuilt hedge born of our will to believe in a better outcome than a prolonged stall or irretrievable reversion to the prior bear market’s mean. That hedge is not so much a light at the end of any tunnel as it is a headlamp that lets us continue to find and mine opportunities in what remain darkly recessionary times.

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