With the deadline looming for an increase in the U.S. government debt ceiling, last weekend several politicians and numerous media sources were predicting a sharp sell-off on world financial markets once trading began for this week. When Monday came, the anticipated market freefall never occurred. Now we are just days away from supposedly exceeding the congressionally approved debt limit with little reaction from Wall Street.

The reality is that while this is an important matter, corporate America and Wall Street understand that whatever happens is not likely to have an immediate, negative impact on them. The debt ceiling issue is currently little more than political gamesmanship. Increasing the debt ceiling cannot resolve the debt or budget crises anymore than raising blood alcohol limits can solve the problem of intoxicated driving.

Each party is trying to use this issue for political advantage. That means members of Congress and even the president will cite extreme repercussions to further their agendas.  The possibility of a major market slide is just the latest threat.

The biggest market reactions are reserved for unexpected events. Political events rarely surprise Wall Street. It certainly is aware of the Aug. 2 deadline on the debt ceiling. Any reaction from Wall Street would have occurred weeks or months before the possibility of default, rather than days before.

Here is an assessment of the situation from Daniel Gross, economics editor at Yahoo! Finance, from a July 26 article:

“It’s more likely that effects of a stalemate would be felt in the stock market than the bond market. Why? Huge deficit cuts, and a suspension of delay in the payment of salaries, benefits and entitlements would contribute to a demand shock, slowing growth (good for bonds, bad for stocks.) It could be that stock investors aren’t watching cable news 24/7. But here, again, there’s a sense that Washington, and even the U.S. economy, matters less and less with each passing day. Consider this: The typical member of the S&P 500 already gets about half of its revenues (and probably most or all of its growth) from overseas. The bigger the company, the less tethered to the U.S. Consider Intel, McDonald’s, Coca-Cola, Apple; their earnings reports show that they are being driven by growth overseas.

“If Washington is going to act on the debt ceiling and the long-term deficit, it will have to do so out of its own volition and sense of responsibility —and not because of the savage demands of the credit and stock markets. Get ready for a few more weeks of brinksmanship.”

There would be a sharp and swift reaction by Wall Street and the rest of the world financial markets if the U.S. government were to default on its Treasury bond debts. But that is not going to occur. The U.S. government has massive revenue sources that it can deploy strategically. In spite of President Obama’s threat that people might not get their Social Security checks on time, that is not going to happen either. Bondholders will be paid. Social Security checks will go out.

If Congress does not reach an agreement by the deadline, expect to see some furloughs of government workers. Watch for Federal offices buildings to close for one day a week. Federal employees might have to forego overtime or see a reduction in hours. In other words, the government might have to resort to the same type of actions as state and municipal governments and private businesses were forced to endure for the past couple of years.

Wall Street tends to lead rather than to follow. American businesses have been trimming down and diversifying since the first ripples of recession more than three years ago. Payrolls that were cut back have not been re-inflated. Inventories are lean. Many of Wall Street’s leading companies are cranking out solid profits. Wall Street is not responding to the debt-ceiling situation because it already has.

Now it is merely waiting for the government to follow its lead.
Flint Stephens

I’m hearing a common refrain from a lot of investors. They see talking heads of the financial media discussing the impressive gains that stocks have made since bottoming in early 2009 and yet they do not see those gains reflected in their accounts. While major indices are generally higher than in early 2009, the truth is that virtually no investor has participated fully in those gains. When one starts looking at specifics, many investors might find that the opportunity for gains during that time is really less than one might imagine.

To explain what I mean, I am going to use the New York Stock Exchange Composite Index (NYSE) as an example, because it includes about 4,000 stocks making it a broad representation of the market. Here are some of the raw numbers since the market peak in October 2007 (these are rounded numbers):

Index high—10,245 on Oct. 12, 2007

Index Low—4,617 on March 5, 2009

Percentage loss = 55%.

Level of Index on July 20, 2011—8,281

Approximate amount still below Oct. 12, 2007 peak—20%

The percentages tossed around when speaking about market gains and losses can be confusing. Many investors (and some in the financial media) do not understand the concept that to fully recover from a 50% loss an investment must make a gain of 100%. For example, if an investment worth $100 loses 50% it is then only worth $50. Simple enough. If that investment subsequently gains 50%, it is then worth $75. A 50% gain does not erase a 50% loss.

So far, most major market indices have not fully recovered from the losses that came in 2008 and early 2009.

Since bottoming in 2009 the NYSE has experienced two strong advances. The first began at that March 2009 low and continued for almost a year. That rally peaked on April 29, 2010 with the NYSE at 7,589 for a gain of 64%.  But that 64% gain did not erase the 55% loss. Even after that impressive rally, the NYSE was still 25% lower than its 2007 peak. The second advance began June 28, 2010. It started after a 12-week decline where the NYSE lost 11%. It bottomed at 6,736 and climbed to a high of 8,671 on April 29, 2011. That is a rally of more than 28%.

But in the case of the most recent rally it isn’t realistic to assume that most investors bought on June 28, 2010 and sold at the peak in April 2011. Many probably experienced the full 11% decline prior to the start of the June 28 rally.

Below I’ve included a chart to help explain some of the points I’m trying to make. The chart shows the price movement of the NYSE over the past four years. The green highlighted area shows the gap between the index high in October 2007 and the current level. The significance is that investors who have been invested over this period still have not fully recouped the losses suffered when the decline began in late 2007. Investors fortunate enough to be in cash positions at the end of 2007 avoided not just a major loss, but all of the emotional stress endured by those who remained invested.

Undoubtedly, many investors did not experience the full 55% decline because the pain of the losses caused them to bail out at some point along the downward slope.

I added a gold arrow marking the period in September 2009. I included it simply as an arbitrary point where it is reasonable to assume that some investors began easing back into equity positions.

Very few investors are lucky enough to buy at the exact bottom after a major correction. On March 5, 2009, no one knew that day would be the low point. After watching the market decline steadily for more than a year, not many investors were ready to jump back into stocks. For investors who were out of stocks when the low point came, it undoubtedly took some time for them to feel comfortable about buying back into the market. In this case, an investor who waited six months after the market bottomed (and bought at the point marked by the gold arrow) actually missed much of the gain that the NYSE accumulated since the March 2009 low.

I added two blue lines to the chart to highlight periods when stocks have generally gone sideways for several months. For the NYSE, those periods have roughly been at the 7,500 and 8,500 levels. The NYSE first recovered to that mark at the beginning of 2010. Then it hovered around or below that level for almost a full year. The second flat period at about 8,500 began in February 2011 and continues.

Most of the gains made by the NYSE since the March 2009 bottom occurred before the end of 2009. The NYSE today is only about 11% ahead of where it was at the beginning of 2010.

Since the bottom of the slide in March 2009 there are many stocks that have made some impressive gains. For example, Apple (AAPL) was at $89 in March 2009 and this week was trading at $388. That’s a gain of more than 400%. Apple is a well-known company and millions of shares trade every day. Many investors obviously participated in some of those gains. Today most investors probably wish they had bought lots more shares of Apple stock two years ago. Unfortunately, we can’t trade using hindsight. We must instead conjecture about the future and so far no one has come up with a fool-proof method for predicting what individual stocks or the market as a whole will do. By the way, investors who bought Apple in June 2008 for $185 a share saw a loss of 52% if they sold at the bottom on March 5, 2009 at $89 a share.

Because of examples like Apple, many ordinary investors feel like they have missed the boat. What they fail to recognize is that for every company like Apple there is another company whose stock is still valued at much less than it was prior to the current economic downturn.

So far, I have not specifically mentioned market risk. When investors hear others talking about their big profits, the tendency is to want to participate. We all want more money and greed is among the strongest emotions. In such situations, investors often are often willing to disregard any consideration of risk.

Let’s use an analogy. Suppose someone overhears some friends talking about the fun and excitement they’ve enjoyed driving cars nearly 200 miles an hour down at the racetrack. As they describe the intense feelings from G-force and acceleration, the listener can hardly wait to get in on the action. The eavesdropper recognizes that there are some potential risks involved with racing, but he reasons that he has driven a car every day for many years, so how hard can it really be?  He spends $150,000 to get a fast car and heads down to the local racetrack.  On his first outing he tops 120 miles an hour and everything seems great. He loves the thrill of the speed. The second time he gets above 150 and decides that racing really isn’t as difficult as one might imagine. He thinks about quitting his job and joining the NASCAR circuit. The third time out in his new car he is coming around a turn at 170 miles an hour when the car hydroplanes on a wet spot. Before he can react he loses control and the car slams into the wall and breaks into thousands of pieces. He might walk away from the crash uninjured, but insurers don’t write policies for race cars, so his $150,000 is gone.

This might seem like an extreme or absurd comparison. However, the risks from investing are just as real as they are from racing. The current market situation is fraught with danger. After more than two years without a significant correction, it is easy for investors to forget how it felt three years ago when stocks were in a free fall. The next major correction might not occur for 20 years. Alternatively, it could start in two weeks.

For professional financial advisers and for ordinary investors, periods of sideways movement like the one currently dominating the markets are difficult to endure. For most of 2011, the NYSE has traded in about a 7% range between 8,000 and 8,600. By comparison, the sideways trading that persisted in most of 2010 had a range of about 17%. It is unusual to see stocks trade in such a tight channel for such a prolonged period. Eventually, the pattern will change and stocks will begin a new advance or a more serious decline. Until there is additional evidence to establish which scenario is more likely, investors and traders need to be patient.

Flint Stephens

The Ulcer Index is a technical measure of investment risk that focuses on downward volatility. Its name comes from the fact that periods of market decline cause the most emotional pain for investors. When it comes to the overall U.S. economy, the monthly unemployment number could be considered similar to the Ulcer Index. When the unemployment rate is high, it will be difficult for the economy to make much headway.

Another unexpected increase in the unemployment numbers for June caused shockwaves for major stock indices last week. According to information from the U.S. Bureau of Labor Statistics (BLS), the June jobless rate climbed to 9.2%. That marked the third consecutive monthly increase since an 8.8% rate for March 2011. This is the designated official unemployment rate also known as the “U3” rate.

The U3 rate is not all-inclusive. For example, it does not include unemployed workers who have given up looking for work. It does not include those who are working part time even though they would prefer full-time employment. The most inclusive unemployment rate tracked by the BLS is called the “U6” rate. According to the BLS, the U6 unemployment rate in June 2011 was 16.2%. That is a half-percent higher than the March 2001 level of 15.7%.

Increasing the employment rate would help the U.S. when it comes to some of its other economic troubles. Consider the current debate over the U.S. debt, for example. If the unemployment rate could be reduced to 6%, that means millions more would be paying taxes. The drain on government services like unemployment compensation, food and housing assistance, and medical care would be reduced, meaning that more money could be directed toward other areas. Of course, there would also be increased consumer spending, which is the engine that drives the U.S. economy accounting for two-thirds of GDP.

So far, however, efforts of the Obama administration and Congress have had little impact in reducing the jobless rate.

The following information comes from e21, a nonprofit, nonpartisan organization that provides economic research and public policy information.

“Back in January 2009, Christina Romer and Jared Bernstein produced a report estimating future unemployment rates with and without a stimulus plan. Their estimates, which were widely circulated, projected that unemployment would approach 9% without a stimulus, but would never exceed 8% with the plan. The estimates, along with real unemployment rates, are posted below:

Fri 8 Jul 2011