The Not-So-Merry Month of May

What a miserable month for investors, especially considering the U.S. is in the process of pulling out of a recession. The stock market should be recovering alongside the economy. What's going on?.

The investing public is motivated by fear and greed. The Bible says we are like sheep, and you can see that in clear relief in the investing arena. The herd flips back and forth between fear and greed remarkably quickly. We have fairly recently been through the worst recession since the 1930's and the bear market that accompanied has left some painful wounds. Much scar tissue.

So, despite largely glowing stats concerning our economic recovery, it seems like every little news item that contains a modicum of bad news is enough to send the Dow down a couple hundred points. It doesn't make much sense, but stock investors aren't known for exhibiting that particular attribute.

The thing that stirred the herd in May is the European Union (EU) situation. Having a common currency for so many countries was always a dicey challenge. Back when the Union seemed to be admitting a new country each week, the new members worked hard to meet the financial requirements to start using the Euro as a common currency. However, once they were in, they relaxed and there was no effective discipline to correct them. Add to that a socialist economic agenda and it was a recipe for failure.

Now Greece has a big debt problem and the EU is concerned that the problem could spread to other members whose finances are also not in good order. The EU has committed close to a trillion Euros to help weaker members meet their debt obligations. However, the key long term question is whether or not those failing countries can move away from some of their socialistic tendencies, revitalize their productivity and defang their powerful labor unions that stand in the way of the required remedial measures. If these countries cannot regain competitiveness, their debt problems will not go away.

As investors, we need to ask ourselves, "So what?" Suppose Greece goes bankrupt. Suppose they are kicked out of the EU? Suppose some or all of Portugal, Spain and Italy follow the same path. Suppose the EU finally just says, "Bad idea; let's return to individual country currencies." So what? The U.S. has operated successfully in that environment before. We can again. Of course there will be turmoil and turbulence in the EU during the transition period. But the world economy should survive. Don't forget that such a turn of events will generate some winners as well as losers. We know some missionaries in Europe who consider the "Euro woes" a major pay hike! European tourism should flourish. (Now is the time for a trip to Europe.) Our exports will gain a temporary advantage.

Regardless of what's happening in the EU, the rest of the world should be able to climb out of the recession. According to my latest Economist magazine, China and India are leading the way and are currently raising interest rates to cool off their economies. The U.S. is following. Brazil is doing fine. There are just a small handful of countries with falling production: Greece, Spain, Hungary and Venezuela. That leaves forty countries listed by the Economist with improving production.

The Gulf oil mess is heart-wrenching as we witness dying animals and out-of-work fishermen and tourist vendors. But the economic impact should not be enough to derail the overall economy. We import most of our seafood, but the price of shrimp should rise. There is a concern that the government regulators and politicians may over-react and hurt production from the hundreds of safely-operating gulf wells.

All in all, the fundamentals for investing in stocks are fairly sound. Emotions, the prime enemy of the investor, will still impart significant volatility to the stock market. Money that flees from stocks usually ends up on bonds, so bond funds have been doing well. We rebalanced stock funds (took profits) in early May after a thirteen month run-up of the stock market. If bad feelings prevail and we experience another twenty to forty percent drop in the stock market, we will be selling some bond funds and buying more stock funds while they are so cheap.

Ain't it great to be so well diversified?