For months, investors have waited for the markets to hit bottom. Yet, while many have expected a quick turnaround from stocks, more experienced investors know that any eventual recovery in the markets could potentially take far longer than most are prepared to wait.
Deja vu all over again
Disturbingly, recent news seems like a replay of last summer's big financial crisis. Take a look at some of the big news items you've heard about lately:
- Banks like Citigroup (NYSE:C) and Bank of America (NYSE:BAC) are still on shaky ground, with new names like State Street (NYSE:STT) starting to appear among institutions with huge losses.
- After seemingly running through every possible alternative, the government's TARP program has come full circle and is again considering buying up toxic bank assets.
- Months of job losses have only accelerated, with companies like Motorola (NYSE:MOT) and Seagate Technology (NASDAQ:STX) among the latest to announce new layoffs.
- Despite numerous short-lived attempts at recovering, major market averages are hovering near multiyear lows once more.
What will it take to get this behind us? I see three things that have to happen before any lasting turnaround can take hold.
1. Investor confidence
As cheap as stocks are right now, people simply don't want to buy them. And it's not just novice investors -- professional money managers have tons of cash on the sidelines but aren't in any hurry to put it to work in the stock market.
A recent survey from Merrill Lynch shows that although fund pros think that the global economy may not get much weaker from here, they're still not ready to buy stocks. Cash levels are at eight-year highs, and 44% of the managers reported being overweight in cash.
It shouldn't surprise anyone that if market professionals can't convince themselves that buying stocks at current levels is a good bet, less experienced individual investors are even more reluctant to buy. And even though stocks will likely rise substantially in advance of any permanent improvement in the financial system and the overall economy, those who've held onto their cash have thus far been rewarded for their patience.
I'm convinced, though, that most people want to be optimistic about the markets. If even a single government program or industry initiative actually works, it'll buoy confidence, which will start feeding on itself. But as long as every attempt fails -- or worse, backfires -- stocks will stay mired in a tight range.
2. Corporate earnings
Let's face it -- quarterly results have been ugly for a long time. Starting with Alcoa's (NYSE:AA) bombshell 10 days ago, fourth-quarter earnings for the S&P 500 are expected by economists to drop 20%. And so far, even companies that beat analyst estimates, such as paintmaker PPG Industries (NYSE:PPG), are turning in significant declines from year-ago levels.
The silver lining, though, is that earnings shortfalls simply lower the benchmark that companies will be compared to in the future. With such low hurdles to overcome, results in coming years will look far better than they would if investors focused on historical results from strong years like 2006 and 2007. In this, at least, most market participants' short-term focus works to stocks' advantage.
3. Lower expectations
Investors have gotten spoiled by previous market downturns. Those who've experienced the 1987 crash and the bear market of 2000-02 know how sudden and forceful the eventual market recoveries that followed were -- and for the most part, investors didn't have to wait long before they made back much or all of their losses.
Yet I'm convinced that it's that sense of expectation, almost entitlement, that will hold stocks back this time around. And while the end of that phenomenon will bring more pain as another round of sellers give up on stocks, I think it will also create the conditions needed to start a sustainable bull market.
That doesn't mean you should stop investing. It just means that you should prepare yourself not to see big gains right away. No one knows when the recovery will come, but I do know that the exact moment it arrives will be clear only in hindsight.
For more on investing and the economy, read about:
- The one stock you must buy.
- Betting on a housing recovery in 2009.
- Has the bull market already started?
