It's hard to keep your head when all others around you are losing theirs. Especially when the only reward for not panicking is watching the value of your portfolio plummet. The almost irresistible impulse is to join the crowd that's running -- even if you don't know whether that mass is about to plunge over a cliff.
In times like those, it's harder than ever to come up with a road map, but a road map is exactly what we need.
The landscape is changing so quickly that no map can pretend to offer more than momentary accuracy, but even the most rapidly outdated guide can tell us when we've missed a turn. It can separate the minor deviations where a bad or good choice doesn't make much difference from the truly decisive forks in the road. And it can give us a sense of when we have a chance to adjust our course and when we don't have any option but to ride out the route we're on.
I can't pretend to have perfect foresight. Regular readers of this column know how often I've been flummoxed by the course of the market in the past 12 months. But I think I can give you a road map to the next year or so that might help you figure out what to do and when. If nothing else, by bringing together and, in some cases, modifying all that I've recently written about what to expect from the stock market in the next 12 months, I can create a guide that's clear enough to show where I agree with or dissent from your own vision of where we're headed. Use it, in other words, to make your own financial plans more detailed, more accurate and more useful.
The road so farFeeling disoriented? The stock market has been moving so fast -- and, until Monday, in only one direction -- that it's impossible to keep up. We've plunged through 1,200, 1,100, 1,000 and 900 on the Standard & Poor's 500 Stock Index ($INX). Each one of those mileposts, the best technical analysts in the business calculated, was supposed to mark a bottom.
Have you been imagining the unimaginable, like another Great Depression or the end of the global financial system? Well, who could blame you? Six months ago, could you have imagined that Bear Stearns andwould have disappeared into bankruptcy? Or that the federal government would have taken over and , the two giants of the mortgage market? Or that the government would bail out with an $85 billion loan and that the loan would turn out to be too small? Or that the Treasury and the Federal Reserve would put together a $700 billion shock-and-awe plan to buy busted financial assets and that the financial markets would sink even deeper into crisis? Or that the world's leading central banks would all cut interest rates on the same day and no one on Wall Street would cheer? Or that the government of the United Kingdom would move to nationalize its banks and that the U.S. would talk about following suit?
So where are we? Let me try to give you a financial road map. It breaks down into five stages.
Stage 1: In the next month or so, a big rallyThe stock market was badly oversold. We moved down so low and so fast that we were way overdue for Monday's rally.
Think of the stock market as a giant spring. It was getting compressed tighter and tighter by the added force of each piece of bad news. Worries about $VIX.X), a measure of market fear, hit 70 for the first time. Stock market historians say VIX readings above 40 or 45 usually signal an oversold stock market ready for a rally. The spring was really, really compressed.and going under? Wind the spring tighter. Worries that squabbles between the United Kingdom and France would undermine European financial markets? Wind the spring tighter. Worries that settling the $400 billion in derivative contracts that involved now-bankrupt Lehman Bros. would send other companies into bankruptcy? Wind the spring tighter. On Friday, the CBOE S&P 500 Volatility Index (
Rallies of this sort in a continuing bear market can easily run to gains of 20%, 25%, even 30%. I think we're not far away from a rally of that magnitude.
What would I do at this stage in my road map? I'd sell into the rally. I'd get rid of stocks that didn't pay dividends, that weren't unbelievably cheap on their future growth or that didn't represent low-cost, long-term options on the next boom in commodities. (See my Oct. 6 column, "Everything's changed now -- for the worse," for more details on what to sell and what to hold.) I might even sell my positions in gold stocks, since they're likely to go down on the resurgence of optimism.
Stage 2: The rally fails in early 2009Think about it. Can you see anything that might happen over the next three months fixing the crisis we're in? Isn't it much more likely that we'll get some new piece of bad news that suddenly shows us that we're about to peel another layer of the onion in this crisis?
Maybe it will be a sudden crisis over a General Motors or Ford bailout that will focus attention on the trillions in derivatives linked to those companies. Maybe it will be a sudden run on the U.S. dollar as news leaks out that China or Singapore or Kuwait has shifted a substantial part of its portfolio out of dollars. Or maybe it will just be news that U.S. unemployment has suddenly spiked from 6.1% to 6.5% as the cumulative effects of job cuts on Wall Street, in state government and on Main Street hit home.