The Bubble of Uncertainty Is About to Burst

 |  Includes: DIA, IVV, SPY
by: Jason Schwarz

We are in the decade of the bubble. This new bubble, which I call the ‘uncertainty bubble’ is different because its price action is negative, however, the bubble-like characteristics are the same as the previous bubbles in tech, housing, and oil. Once mainstream momentum attaches itself to a cause, it will run beyond what the fundamentals warrant. This bubble has been especially dangerous because there is nothing that investors despise more than uncertainty. The bubble of uncertainty has caused a rather dramatic stock market sell-off but this bubble is about to meet the same fate as its predecessors-it is about to burst.

The Obama Effect

Back when the Presidential campaign began, nobody knew for certain who Obama was or how he would govern. He was inexperienced and hadn’t voted his opinion very often. He was the ultimate candidate of uncertainty. This worked to his advantage in a brutal campaign where all sides were trying to distance themselves from the Bush administration.

In a weird way, this anti-Bush obsession inadvertently turned anti-American. The perception became one of American despair, American fear, and American greed. As a result, the majority of Americans became obsessed with finding an anti-Bush replacement and they knew they had their man in Obama. Ironically, many people paid no attention to the details of what he said, instead they focused on his tremendous ability to articulate, to inspire, and to lead. Even moderate voters jumped on board, not because of any particular policy ideas but because they yearned for change. Let’s not kid ourselves, we all know there was a tremendous ‘cool factor’ in supporting Obama. It was a historic moment. But the true reality of how he would govern remained a mystery.

The Larry Summers Effect

In trying to uncover the mystery of Obama governance, many supposed that this recession would protect us from his liberal agenda but it hasn’t. If anything, it has emboldened it. Much of this can be attributed to his top economic advisor, Larry Summers.

Summers is a seasoned veteran. He learned a lot during his days in the Clinton administration. As a member of the Clinton cabinet he witnessed how Clinton was handcuffed by the economy he inherited from Bush Sr. Summers knows that if you are a slave to the recession you will never accomplish your goals. To Summers and Obama the liberal agenda means everything. It’s more important than re-election. Those who were hoping for a repeat of Bill Clinton, a President who talked liberal but governed as a conservative, have been let down.

Obama is not Bill Clinton. He is the opposite. He talks in a way that moderates can agree with but then he governs as a liberal. Wall Street has been stunned by this realization as they don’t know what to do with a President who is more concerned with the lower and middle classes than he is about them. This situation has led to a lot of negativity coming from Republicans and the conservative media but one good thing is happening. The uncertainty of Obama governance is slowly dissolving away. Even if you don’t like how things are shaping up, it’s important to remember that any plan is better than no plan.

The Obama Stock Market

After a miserable 2008 many assumed that the market could never have a repeat performance. So far, it’s been worse. January was the worst January in history. The market has now dropped in 21 of the 32 days Obama has been in office. Uncertainty spread from the campaign trail into the banking sector. So many unknowns made it virtually impossible for investors to make intelligent decisions and so the selling has continued.

As Warren Buffett says, in the short run the market acts as a voting machine but in the long run it acts as a weighing machine. We all see the negative vote but we are now at the point where another significant move down in the stock market represents the pricing in of events far worse than a recession. Our economic backs are against the wall. The bubble of uncertainty will burst as detailed solutions replace the unknown.

It’s important to remember that Obama ran a flawless campaign and he has been very actively engaged in solving the primary problems of this crisis: banking, unemployment, and housing. It can't happen in one day but the gradual economic healing process has begun and will soon start showing results. The market will transform from a voting machine to becoming a forward-looking, fundamentally driven entity that is able to compare itself year over year with the 2008 recession. With every passing quarter those comparisons get easier and easier. Historically speaking, the current economic fundamentals do not warrant a 60%+ market sell-off. Economic history is telling us that we are in bubble territory and that the potential for a burst is very real.

Conclusion #1

Ford (NYSE:F) sits at $1.85. GE is at $6.85. Bank of America (NYSE:BAC) is at $3.30. CBS is at $3.40. A host of other former stalwart stocks are priced in the single digits. If Washington’s long term plan works to restore any form of certainty and confidence in this economy, then these stock prices represent a huge opportunity.

The 2009 selloff that has taken us from Dow 9,000 to Dow 6,600 is based more on uncertainty and negativity over who Obama really is than it is on economic fundamentals. I understand that each sector in its own way is facing uncertain times but the root of this uncertainty comes from Washington.

2009 is a year in which Washington transitions from economic referee into economic player which in itself has made Wall Street uncomfortable. Having a relative unknown like Obama leading the new economy has only added to market frustration. In the same way that many ignored his campaign promises, they are now ignoring the formation of his plan. Endless uncertainty will not prevail.

Conclusion #2

Investors need to understand that times have changed. This decade of bubbles has changed the investment climate of today and it has altered the way investments should be handled in the future. The days of buy and hold are over, because of the real risk of 40% drops in the stock market. These kind of drops are too much to handle.

We have now had two of them in the last eight years and the potential for a third is on everyone’s mind. I have written up a booklet called 'The Crash and Burn of Buy and Hold' that is available if you click here. This handbook will help you to adapt your investing strategies to the new, extremely volatile environment that these bubbles bring. I don't want anyone getting left behind.

Disclosure: None