“Now what are you going to do? You done dropped your gun in the last scene!” ~ Eddie Murphy
I don’t know about you, but I find that there is a reason certain lines from pop culture seem to have staying power. In a meeting just last week, one of my colleagues was discussing a remote probability. Immediately someone (okay I confess, it was me) said, “So you’re telling me there’s a chance?” Everyone laughed. It isn’t because the line is that funny, it is because everyone at that table recognized it as a line from the movie, “Dumb and Dumber.” It is these little things, the inside jokes, that in part make up a culture.
Wall Street also has a culture, and a language. Often times the market does what it does because of a Wall Street script that is known by those who share the culture and know the punch line before it is delivered. There are naysayers, and frankly I’m one of them. There is no actual script; history does not have to repeat itself. However, it often does. Why? I believe it is the phenomenon of the self-fulfilling prophesy. It happens that way because we made it happen that way, because we believed that is the way it was going to happen.
However, every once in a while there are two (or more) possible scripts. We are at one of those moments now. We have had a bear market, and we have rallied off the bottom; but now what? One possibility is that the bounce we have seen over the last six weeks was just a “bear market rally.” Long-lasting bear markets often have dramatic rallies, but they eventually peter out and the bear market resumes; that is possible. Yes, I am saying there is a chance.
It is also possible that bottom is in. We have just seen the first move in a lasting rally; in that script we have a dip, and then the rally resumes. This is the more likely scenario, in my opinion. Earnings have held up much better than the pessimistic consensus view of a few months ago predicted. Economic data has been mixed but employment has held up, the consumers are spending, and inflation may have peaked. This would all lead to a resumption of the rally.
Of course, the thing about the future is that no one really knows what it is. Don’t say that too loudly around Wall Street. The script says that when the Fed raises rates, there must be a recession. Of course, we are in a recession (as defined for the entirety of my career), but those who deny the current data also seem completely certain that a recession is on its way; they keep saying that things must get worse, but the truth is that we don’t know that.
That is why we have to be prudent in our decision-making. The top-down headlines will make one depressed, but the view from the bottom-up is very different. Just this past Friday I met with someone who told me that everyone she talks to is busier than ever; that doesn’t sound like the gloom-and-doom reports we hear in the news. The truth is that it is far easier to project the probable future of a particular company than it is to predict an entire economy.
Some companies are struggling in this environment, but others are hanging in there. To me, this reads like the script where we take a step back and then resume the rally. Of course, we have to keep watching to know for sure. That is why we remain cautious and defensively postured. The key to knowing what to do now, is to think through the different probabilities and have a plan for each scenario. Step one: let’s listen to Mr. Murphy and make sure we don’t drop anything that might be needed later.
Chuck Osborne, CFA