Reading Mr Market's Mind

Judging from the run that the market has been having in the past month, including a successful tech IPO on the NASDAQ (a games company from China which says a lot in itself), you might think we are headed out of the economic doldrums.

I think that is wishful thinking and that this "bounce" is unlikely to be the cure for all the problems our economy is facing.

There are some positive signs; housing in some of the hardest hit regions might be bottoming, healthy banks are making money and sick banks are making money in their good lines of business, and consumers are not in as foul of a mood as they were at year end.

But the macroeconomic picture is not good. We've got a federal government running up staggering deficits, we've still got trillions of assets that have bid/ask spreads that are so wide we don't have functioning markets in some assets, and we've got an auto industry that at best is headed for a wholesale restructuring this year.

A rally was inevitable. People can't keep their money under mattresses forever. A small shift in sentiment can lead to big moves at the extremes.

My head is in the same place it was last October and November when "the world was coming to an end". I think we are in for a bad 2009 and a weak 2010 and maybe a better 2011. I also think we are going to see many large industries changed fundamentally by this downturn.

So what is an investor to do? First, I believe you must be investing, but carefully. Second, pick your sectors with care and stay away from sick companies, balance sheets, and industries. And third, have a defensive posture with plenty of cash in reserve.

It's certainly not as bad as many thought in the fall of last year and it's not as good as everyone secretly wishes it would be. We've gone from greed to fear to something else now. It's a better place but not necessarily a safer place.

Reblog this post [with Zemanta]

Comments (Archived):

  1. pedalpete

    I’m curious about your comment re: staying away from ‘sick’ industries. Aren’t these industries where there are often the greatest potential? I’m thinking Google in the days when search was dead and overdone.

    1. fredwilson

      I mean the us auto companies, housing, banks, insuranceI don’t think the internet has ever been sick, even in 2000-2002 when I made some of my best investmentsOut of favor is a great place to invest

      1. pedalpete

        Being that I’m in the ‘currently doomed’ music tech industry, that comment makes my heart sing!

        1. fredwilson

          Music tech is only doomed to the extent that artists keep licensing their rights to clueless people

  2. aanwar

    Interesting point. Well, let’s hope you are right and we’ll be better in 2011. The aggregate demand should increase to give the economy a jolt! 😉

  3. rkorba

    Sir Fred — Have to admit that my “randy the grammar snipe” serendipitous dual read of your: “…the NASDAQ (a games company from China which says a lot in itself), …”amused me. I think we ARE close to the point where NASDAQ, and the economy and Creditor committee for the coutry is indeed a Chinese games company. Ugh.

    1. fredwilson

      That was one of the thoughts that went through my mind when I wrote that

  4. Ted Rogers

    Fred,I was one who stayed away from the passionate political arguments the last few months but your comment “We’ve got a federal government running up staggering deficits…” and the fact that the administration seems to be conflating VC and hedge funds for the purposes of future regulation makes me want to ask 1) whether the Obama administration is governing the way you expected and 2) whether you support them as strongly as you did prior to January 19th. I am beginning to wonder whether the administration’s center of gravity is much farther left than I previously thought.

    1. fredwilson

      I don’t oppose the idea of using “overwhelming force” to attack the financial downturn. The only other approach that would have made sense is complete laissez faire approach and let all these companies and banks go underI think the latter would have resulted a protracted downturn but also an accelerated reshaping of our economyObama’s approach is likely to return the economy to some form of ‘normalcy’ but then the question is where do we go from thereI am more worried about medium term than the short term right now

  5. kidmercury

    “It’s certainly not as bad as many thought in the fall of last year and it’s not as good as everyone secretly wishes it would be.”patience, fred, patience. things will get worse in time for everyone, that much is virtually certain. the fed/govt is trying to restart the phony finance economy and create another bubble, but there’s nowhere to go. the economy is so plagued by malinvestments, and interventions are only going to result in more malinvestments, as well as price inflation for consumer goods.the solutions are, of course, simple: restore sound monetary policy, reduce govt spending, and have policies that enable and encourage savings, unlike current policies. savings leads to credit leads to investment and growth. no savings ensures none of that, and current policies are not encouraging hindsight two things will be obvious:1. the bailouts are essentially a form of robbery, and show who obama really works for2. the american people thought they were better off being ignorant and coddling themselves with lies while they were being robbed2009 will end up worse than 2008, and 2010 will end up worse than 2009. as for 2011…..let’s see if the american people wake up and start addressing the real problem; by 2011 they might be in enough pain where they seek the Truth, but at this point i’m uncomfortable betting on the american people being responsible for their government, as that is clearly not the trend. so we’ll see about 2011.

    1. fredwilson

      I’d bet you on this one but I already have made my bets in this regardAnd I am sure you have too!

    2. anumberone

      I concur. The bailouts, TARP money (with their strings attached), and govt. runups of enormous debt is not good. Less government is the answer to spur innovation and industry. Always has. Here are some common sense ways to address the problems we face that together would revitalize the economy – http://hannity.blogs.foxnew…Read the 6 ideas to save America. They are refreshing to read and demonstrate concrete ways to address our most critical problems with solutions that are working now. Some of them are actually free (e-verify) and been a large success, but in danger of not being extended. If only all politicians supported in a bipartisan fashion and not their hidden agendas, we would have a clear path out of this mess, instead of the same partisan political nonsense. It’s like a soap opera in slow motion where you already know the storyline. The administration has scored zero on bipartisanship. This is not the “change” that people voted for…

  6. Paolo

    “People can’t keep their money under mattresses forever”… I think this was more like a technical bounce and that people in general will stay away from equity for another long while. IMHO we most likely reached the bottom at the beginning of March, but a full financial recovery will still take many many years. I expect to come back to the early 2007 levels in 2015. Hope so…

    1. fredwilson

      When I said “people can’t keep their money under mattrsses” that was a metaphor for all capital, including institutions, hedge funds, etc

  7. Miles Rose

    we are in a deflationary period. buying assets now has to be done very carefully as its the “falling knife syndrome”, if you don’t buy at the bottom you will get hurt. If history teaches us anything what we have just experienced is a massive loss of trust and this bounce will be more like 1930 and will be followed by a long tail of downward trending of asset values. As a friend says, “how much would a Cadillac be worth if you couldn’t finance it”. Not very much. Its hard to learn to wait but sometimes thats what you have to do. That being said, with costs lower its a great time to start up something which offers real value because you will not be getting new customer dollars but repositioned customer dollars which hopefully will end up in your pocket.

    1. fredwilson

      Yes you are right as usual MilesBut I think you have to look at the nasdaq and the dow differentlyI wrote about this last fall…I think it may be 1938 for the nasdaq, not 1930

  8. C Coulson

    I am a bit more optimistic about the future. This is a miserable time we have been through, and if you are lucky your portfolio has been cut in half and your real estate by a third. As dark as it is today – in general people are pretty crafty at figuring out how to build and make a buck.Three years ago, financed by cheap debt, private equity/LBO firms were going to privatize the whole stock market. If companies got in trouble, every restructuring just passed on the assets to another leveraged structure. Today there is no new debt available unless your are a top credit. Debt holders are now having equity crammed on them by over leveraged enterprises. Non-competitive companies are being liquidated under Chapter 7.Most importantly the end point of de-leveraging from a debt crisis is more equity. Capitalism needs capital and the future is equity not debt.New equity will demand higher returns because it no longer sits on top of cheap debt, and legacy public equity has rightfully had its valuations cut. I am biased because I run an equity market, but the future I am planning for should be filled with lots of interesting opportunities for equity investors and a lot more equity in capital structures that will need to be traded.The capitalist initiative to build, create and earn will need to be fueled by equity. Enterprises and entrepreneurs will adjust their expectations downward of what their business is worth and refocus on how additional capital can help them grow. Of course equity will be more careful, and get higher future returns from better valuations.The Chinese NASDAQ game company is one thing, better news is GS is now looking to raise more equity. Part to get out from under the TARP, but more so because they see interesting places to deploy capital and earn future returns. Look for more companies raising fresh equity to grow and create earnings rather than fill holes in balance sheets.So while there are still reasons to be nervous of the recession hang over and bigger government, people are pretty crafty at making a better life and the future should be a good place for smart equity capital to buy and invest.

    1. Chris Dodge

      Goldman Sachs and TARP really makes my blood boil. They got paid out 100-cent on the dollar for their AIG bets through a backdoor deal without any taxpayer disclosure, representation, or upside participation.All the while complaining about being under the government’s thumb via their original TARP funding.What nerve!

    2. fredwilson

      I agree that deleveraging means more equity and less debt and it is very encouraging to see offerings of equity start to happen

  9. Alex

    Good post. At this juncture, I’d much rather continue to see doubtful commentary than en masse irrational exuberance. Comparisons to previous downturns notwithstanding, no one knows how this exact mixture of global stimulus, global recession and global distribution of poor long-term investment planning will play out in either the short term or the long term, but it’s better to be treading forward cautiously (with equal grains of doubt and optimism).I think we’re past the bottom, that we’re past “falling knives”, and that careful winnowing of the wheat from the chaff will prove beneficial to those willing to step back into the market as we get a few up and down sideways moving markets.

  10. AJ

    Your post has SeekingAlpha written all over it. Every single sentence.You might also want to check, they (SA, MO, DR) seem a bit economically armageddonish. But then again, only the paranoid survive.

    1. fredwilson

      I assume this post ran on seekingalpha. The generally run my market oriented posts

  11. Roman Giverts

    Regarding the point about keep investing, interestingly some of the angel investors I know are now more keen on investing in start ups now than before. For the high net worth guys, the money has to go somewhere, and they feel that right now start ups are in many ways LESS risky and less volatile than public companies. I think the logic is (1) if I invest in start ups at least I can help influence their success, and (2) if I invest a million in dollars in 5-10 start ups, I know I won’t lose 10% value in 1 day as I have in the stock market.not sure it’s entirely logical b/c it’s more likely you lose the entire 1 million in the start ups, but on an emotional level I can understand what they’re thinking, I’m losing in the stock market so i might as well try something different that will get me off the current rollercoaster.Fred, what do you think? Emotional or logical?

    1. fredwilson

      Logical, particularly if you have good deal flow, good dealk taste, and enough diversification across companies

  12. Alan Kelley

    The market’s rally has been driven primarily by a change in the perceived slope of the economic decline. The market has gone from worrying about the economy dropping off a cliff for a long period of time to thinking that the economy is sliding downhill.The consensus among professional investors and others remains that the the economy will be bad in 2009. I don’t know of anyone who thinks we are heading out the economic doldrums now. It’s just that the market is pricing in less risk of a protracted steep decline.

    1. fredwilson

      I agree with you

  13. julie_poplawski

    I feel like we, Americans – maybe humans in general.. are an all in all self motivated, self absorbed, and self inspired! We just cant stay depressed for too long, it’s boring. That’s why there are always bulls and bears and 7-10 year business cycles…

    1. fredwilson

      So true