What Now?

It's been a confusing few days in the markets. Oil had a record drop—you read that right—drop, last week. After some big losses, then some decent gains, now stocks are just treading water. What gives? Even more important, what to do?

Save building a time machine to go back and perfectly time any one of the relative highs we've seen over the past few volatile months, there's nothing to be done about what just happened. (Then again, if you could create such a machine, we'd wager you could just license the technology until you could buy Bill Gates four times over, so such fooling with stock markets would be moot.) Investing isn't about fretting either recent or long past history. Observe it, measure it, create hypothesis and learn from it, sure. But investing today how you wish you could have 6 months ago, based on nothing more than regret and pain, is usually a good way to make a major error.

All you can do as an investor is ask, "What's likely to be next?" "Next" being not the next week or few months, but at least the next 12 months—give or take a touch.

So what's likely to happen next? We can tell you what's not likely to happen. IndyMac won't fail again. We won't be surprised by huge asset write downs. (We'd be surprised if there weren't more, actually.) Bear Stearns isn't going to surprise us by being a cheap acquisition nugget. Freddie and Fannie won't suddenly be front page fodder for possibly needing a government leg up. All that's done. It wasn't any fun, but it's done.

Another unlikely scenario? Stocks being down a lot from here 12 months hence. Their recent big drop reduces that likelihood somewhat. But so does the fact sentiment is far detached from reality. We haven't seen galloping growth, but neither have we seen the recession that's been nearly uniformly expected for the past 12 months. And, with Q2's GDP announcement due next week, we wager too-dour expectations will get beat again. Financials earnings have been lousy—partly due to poor risk management, but also partly due to accounting fictions and asset-write downs. Strip out Financials, and overall Q2 earnings would have been north of 8%—very respectable.

Are things all wine and roses right now? No. Are they as bad as folks fear? Decidedly not. Are Financials in the midst of a post-bubble phase, like Tech was in 2001, leading to an aggravated bear market? Absolutely not. Yes, Financials stocks have fallen quite a lot, but if you compare the run up in Financials to Tech's peak in 2000 and Energy's in 1980 (our last two sector-led bears) you notice something remarkable—there never was much of a run-up. Compared to Tech and Energy, which had big spikes—stocks up nine- and five-fold over just five years—Financials looks like a mild bump.

That doesn't mean Financials can't continue to suffer. And that doesn't mean you'll wake up tomorrow to headlines reading, "Just kidding! Everything is fine now." But that pervasive dour sentiment in light of fundamentals that are better than anticipated gives stocks a tremendous wall of worry to climb.