"A secular sideways market."
That's the best succinct description that I've heard so far of the stock market we're in. It comes from Jack Ablin, the chief investment officer at Harris Private Bank, at a panel that we shared at the recent Las Vegas MoneyShow.
At the same conference, Sam Stovall, the chief equity strategist for Standard & Poor's Capital IQ Equity Research Department, on another panel I had the privilege of sharing, peered into his crystal ball and offered that the gain on the Standard & Poor's 500 Index ($INX) would be about 4% in 2012. With lots of volatility -- so much so that this year, Stovall told Bloomberg, a 5% move should be considered just "noise."
It's reassuring to me these two smart market analysts see something like what I called the "new paranormal" market. (See "5 rules for an 'X-Files' market.") In my paradigm, that market is characterized by lots of volatility but not much net gain -- Ablin's "sideways" -- and achieving an annual return of 5% (or Stovall's 4% for 2012) should be considered a major achievement.
This is still a paradigm under construction, and I'll post a link for you to get a copy of its latest revision from the MoneyShow on my website in the next few days.
Jim Jubak
But watching the market action and listening to investor sentiment over the past few days has already suggested a new danger among the model's elements. I'm calling it "Deflationary Investor Sentiment." And I think it's a major obstacle to achieving even the 4%-to-5% returns that characterize a secular sideways market.
Let me start by telling you what this is, why it's dangerous and what to do about it (I'll also include a few stock picks for execution during the current sell-off).
Waiting for the other price to drop
The easiest way to describe Deflationary Investor Sentiment is to use Apple (AAPL) as an example.
Not so long ago, May 10 to be precise, I wrote a column on careful bargain hunting, "10 stocks for the bad old summertime," and suggested that Apple was a buy when it dropped to $560 or lower. That would mark a substantial 13% decline from the stock's $644 intraday high on April 10.
The shares closed at $558 on May 14. Did you buy?
And at $546 on May 16. Did you buy?
How about Thursday, May 17, when hedge fund managers apparently all decided over breakfast to take profits and the stock fell almost 3% to $530?
If you didn't buy -- and most investors didn't, or the stock wouldn't have continued its descent -- the most likely reason is Deflationary Investor Sentiment. You didn't buy on May 17 at $530 -- even though Apple shares were down 17.7% from the $644 high -- because you thought that by waiting, you could get it for even less.
This is classic deflationary thinking of the kind that we're familiar with from Japan in that economy's lost decades. In Japan's deflation, consumers put off purchases -- a car, a futon, a Sony TV -- because they believed, usually correctly, that these goods would be cheaper tomorrow. Deflationary psychology forms a self-fulfilling prophecy because less current buying means less demand means price cuts as companies try to jump-start demand.
I think you can find the same thinking in the stock market right now: I didn't buy Apple at $560 yesterday because I believed I could get the shares at $530 today. And now that the stock is at $530, I'll hold off buying today because I'm waiting for $520 tomorrow.
A different kind of deflation
Despite the similarity in psychology between economic deflation and stock market deflation, though, there is a major difference: the speed of a potential reversal.
Economic deflation is notoriously hard to reverse, which is why central bankers -- such as Federal Reserve Chairman Ben Bernanke -- are so determined to keep it from taking root.
Stock market deflation can be sticky. Looking at the Apple chart, it's easy to see why an investor might decide to wait until the shares were closer to the 200-day moving average at $457 before buying.
But unlike economic deflation, which pretty much takes a change in the purchasing psychology of a nation to reverse course, in the stock market all it takes is buying by a significant minority to reverse the direction of prices.
That's because once prices start to moving up, another powerful investor emotion begins to kick in. We don't want to be left behind in a rally, so we buy because prices are moving up -- in just the same way that we sold when prices were falling because prices were falling.
Stocks and fund mentioned in this article include: Schlumberger (SLB), McDonald's (MCD) and Jubak Global Equity Fund (JUBAX).
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