- Markets are discounters of known information, so they tend to be jolted from their trajectory by unexpected events.
- Investors must look inside and outside the US for potential risks for markets. It's precisely where the crowd isn't looking that a big unexpected negative can emerge.
- Investors tend to "fight the last war," meaning the wounds from the most recent bear will continue to sting for a long time to come—but surprises (not discounted information) are what investors need to vigilantly monitor.
Life's full of surprises—and for markets, that can be good or bad. Markets are discounters of known information, so they tend to be jolted from their trajectory by unexpected events. Take a highly pessimistic market and add some pleasant surprises, and stocks can move up quickly. Likewise, combine a recovering market and a major, bad surprise, and the results can be less than pleasant for hopeful investors.
Toward bear market bottoms, where uncertainty is high, investors' nerves tend to be more rubber than steel. They're likely to react more strongly to large, unexpected events—in both directions—until the event's significance can be fully digested. If the events are powerful enough, they can influence markets for some time. (For instance, Germany's hostilities led to the outbreak of World War II, disrupting the S&P 500's market recovery.) This means investors must be constantly vigilant of potential market risks and catalysts, and carefully weigh their import if they occur.
But that's only half the battle. The other part is looking everywhere for potential surprises—not just the US. Market-moving surprises can take any form and come from anywhere. For example, US Financials' problems are well-documented in headlines today, but just because some storylines might be discounted doesn't mean all possible ones are. Overseas, there's geopolitical uncertainty: Thailand's political protests led its Prime Minister to declare a state of emergency, Somali pirates are threatening to US and French sailors, and North Korea continued to test long-range missiles, violating international rules. All are good reminders to constantly look inside and outside the US for potential risks to market recovery.
So far, these developments abroad are small events, and markets have reacted benignly. They recall days past in this decade when terrorism and unrest dealt blows to markets, which ended up stabilizing quickly. Even so, events like these are worth keeping an eye on, especially when the media is focused on domestic worries. It's precisely where the crowd isn't looking that a big unexpected negative can emerge.
Stock market forecasting is always about the future. Yet investors will remain hung up on the past for a good long time. Investors tend to "fight the last war," meaning the wounds from the most recent bear will continue to sting even as recovery takes hold. In times like these, we're not surprised shaken investors focus on painful past events—but surprises, not discounted information, are what investors need to vigilantly monitor for clues about possible market risks ahead.