The markets had a temper tantrum. A big one.
Fed Chairman Bernanke's comments last week were widely anticipated. And, in fact, his remarks were far more moderate than many expected. Some had feared the Fed would start pulling back immediately, buying fewer bonds, creating less new money and credit in the banking system.
Instead the Fed Chairman praised the economic growth path of the economy, and said that later this year it seemed likely that the economy could grow on its own, with less help from the Fed.
Think of it this way: If you had a relative in intensive care for weeks, barely able to breathe on his own, and finally the doctor came out and said the patient had turned the corner, and was ready to be moved out of intensive care, you'd be cheering. A recovery is always good news, however long it takes to get there.
But like a toddler that is used to getting its way by screaming, the "smart money" let out a collective yelp. No more attention from the Fed, less money moving into the system, seemed like very bad news.
Never mind that there is a vast difference between "tapering" (which the Fed said it would do as it provides slightly less new credit) and "tightening" (which means withdrawing credit and sucking it out of the economy.) And never mind that the Fed's 5-year money creation spree hasn't really triggered a strong economic recovery. A good portion of that money just moved into the stock market, pushing prices higher.
[See May 21st commentary: "Money Fuels Markets"]
When the market falls, there are always pundits ready with explanations. But the Fed's action wasn't really a surprise. And the concerns over a China slowdown and problems in their credit system were nothing really new. Ditto the excuses about Greece and the Euro. All that bad news was around for months as the U.S. stock market made new highs. Yet, as if a switch were flipped, the sellers piled on -- with more and more excuses for why the stock market sold off.
One of the first things I learned as a young floor trader is that the market is ruled by two uncertain commodities: Money and Emotion. And when money moves emotionally, you have to stand back and let the market take its course. Over the long run, the market is ruled by fundamentals -- but you never want to take action in the midst of this kind of emotional move. Investment success comes from disciplining yourself to take the long-run view. (I'd be willing to bet that Warren Buffet wasn't selling into the decline, and maybe was even buying some bargains.)
Your only other choice is to become a trader, which means you have to be right three times: when to get in, when to get out, and when to get back in again! But you must decide in advance which you are -- trader or investor. Learning on the job can be an expensive lesson.
So here we are with the popular averages still up in double digits year-to-date, and still up 126 percent from the DJIA 12-year closing low of 6547.05 on March 9, 2009. Despite the sell-off, the Dow Jones Industrial Average is up nearly 18 percent from just a year ago.
If you were kicking yourself last month for not being more invested as the market made a series of daily new highs, then this is your chance. Remember, it was only a couple of weeks ago that you were wishing you had invested more.
But you're probably worried about kicking yourself in the coming months if you stay with stocks and they decline even more. Well, what's your alternative? You could put the cash in a money market fund. But don't delude yourself that rising interest rates in the 10-year Treasury bond market will translate into higher short-term yields on money funds and CDs. The banks aren't about to pass that gift along until they've made more money on the spread.
So, your only other alternative is bonds, which at this point are significantly more dangerous than stocks. Remember, when interest rates rise, bond prices fall. So if you own individual bonds or bond funds, the market value of your investments will decline sharply in a rising rate environment. The longer the maturity of the bond, the larger the drop in price.
Awash in Cash
Think of it this way: the whole world is awash in cash. The Japanese central bank is printing like crazy, to make the yen cheaper and its exports more attractive. The European Central Bank has demonstrated that it will create credit to rescue its system, or at least the significant parts of it. And China is faced with the tough decision of reining in credit and facing a middle class rebellion, or allowing credit to move back into its system.
The governments of the world have learned the lessons of austerity and depression. No central banker, least of all Ben Bernanke, wants to preside over an economy that is swirling down the drain. When push comes to shove, they will print. Count on it.
And don't be fooled by the tantrums of a market that doesn't get all it wants at the exact moment it wants it! Even two year olds can only carry on a tantrum for a limited amount of time. And that's The Savage Truth.
P.S. If you followed this logic, then this might be a time to take another look at a mutual fund that invests in a diversified portfolio of dividend-paying gold mining companies. Those stocks have been hit harder than bullion, which itself has taken quite a nosedive. This would be a speculative position, and appropriate only for a small portion of your risk capital, and only for those who have real patience and self-discipline.