In A Tectonic Shift

November 04, 2011

Given the extreme recent market volatility, history may not be much of a guide right now.


Financial markets have obviously been on a roller coaster ride in recent months. Between July 22 and August 8, the S&P 500 declined 17%. The index then gyrated for eight weeks between 1100 and 1225 before soaring 17% from October 4 to its recent high of 1285 on October 28. At present, the S&P 500 is about even for the year.



Such extreme market volatility has historically been associated with intermediate-term bottoms in the stock market that have led to healthy positive returns looking out over the next year. But these are obviously not normal times, so history may not be much of a guide right now. We are in the midst of a tectonic shift in the global financial and monetary system and have reached the point of recognition that the major developed economies are at or near the end of a debt pyramid that has been over three decades in the making. Unfortunately, policy makers by and large continue to opt for short-term “fixes,” and there is no fundamental solution to the debt crisis in view. It is hard to have conviction about any particular investment outlook in this environment.

The strength of the stock market rally off of the October 4 bottom, combined with the fact that governments and central bankers are working overtime to placate markets, suggests that the lows in risk assets are in place for 2011. However, the scope for additional upside beyond the recent highs appears limited. Markets will remain volatile, and there are numerous uncertainties that could tilt markets one direction or the other.

Europe remains an unpredictable quagmire, and presents an ongoing risk of systemic failure. The outlook changes by the day, and lately by the hour. If the eurozone crisis leaves the front pages of the financial press, it would be a welcome respite, but unfortunately only a temporary one, because nothing resembling a durable solution to the underlying insolvency problems has emerged. In the end, massive losses will need to be taken, but it is not clear where the money will come from.



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