Investing: 3 Walls to Watch

by: Balance Junkie

Most of us can read the writing on the wall; we just assume it’s addressed to someone else.

~Ivern Ball

Market and economic commentary over the past few months has contained numerous references to walls. Setting aside the irony of the fact that the seat of American capitalism rests on Wall Street, we’ve also heard about the wall of water that washed over Japan and subsequently complicated the global macroeconomic picture. Add that to the Wall of Worry.

There are 3 kinds of walls mentioned in a lot of market discussions these days. Each one seems to take its turn in the spotlight and ironically, bulls and bears alike seem to be able to use all 3 walls to build their case. The one left standing may determine your investment success over the medium to long term. In the short-term, of course, anything can happen.

I’m talking about the Wall of Worry, the Wall of Debt, and the Wall of Money. Let’s take a look at each of them to see how they’re constructed and how the bulls and bears might view them differently.

The Wall of Worry

Most of you have heard of this one before. The Wall of Worry is made up of all of the things investors worry about. Your Wall of Worry probably looks different than mine. One investment advisory identified 50 reasons to reduce your risk. (Hat tip: Rob Carrick)

It is said that great bull markets have to climb a wall of worry. I’m not sure that’s ever been truer than it is today. This market has rightly been dubbed the “Teflon market.” You can throw anything at it and it just keeps going higher.

The globe is awash in debt. Geopolitical tensions are rising. The world’s third largest economy just suffered an unprecedented series of natural and human-assisted disasters. Any one of these could have put a serious ding in the major averages. None of them have been able to scratch that Teflon.

Bulls will say “Case closed.” You’ve just defined a bull market. As long as the indices continue to shrug off bad news, the bull market is still in force.

The bears will likely remind us that cooking with Teflon can be hazardous to your health. You may not see the effects for a while, but it eventually takes its toll. They point to the Wall of Worry and warn that the fact that it hasn’t fallen on top of us yet doesn’t mean it won’t at some point.

The Wall of Debt

The massive tally of global debt, is, in theory, just another brick in the Wall of Worry. But the problem is large enough, and complex enough to warrant its own wall. Greece, Ireland, and Portugal have all been battling to maintain the confidence of the bond markets while the U.S. and U.K. try to wrestle their own mounting fiscal crises. If the debt problems are not resolved, the economic recovery will fail, and we could easily face another financial crisis.

The bears will argue that solutions to the debt crisis have so far involved taking on more debt. That will never work, they say. Bondholders will need to take their haircuts and banks will need to take a hit. That will spawn instability in the markets for a time, but we’ll have a healthier financial system in the end.

The bulls will counter as follows: While multi-trillion dollar bailouts may have exacerbated the debt problem, they have in fact saved us from another Great Depression. Just look at the major averages. Most have doubled from their March 2009 lows. Things are starting to look a lot better in the real economy as well. With the possible exception of the U.S. housing market, confidence is returning.

Once the real economy starts firing on all cylinders again, we can eventually grow our way out of debt. So say the bulls. But the bears are warning that that ship has sailed. The numbers have simply become too large. Soon, servicing the debt will become an issue and borrowing costs will rise, accelerating the eventual crisis point.

The Wall of Money

The Wall of Money could refer to the massive liquidity central banks have provided by way of various iterations of Quantitative Easing. It could also refer to the seemingly infinite taxpayer backstop of global financial institutions. Most likely, it’s composed of both.

The bulls hail Ben Bernanke as the saviour of the global financial system. They point to the swift actions of governments and central banks as the reason behind the economic recovery. Don’t fight the Fed. You’ll be destroyed by the money tsunami.

The bears counter that the market rally, while impressive and unpredictable (at least by the bears), is nothing but a mirage. It may be built on a wall of money, but that money is only made of paper and therefore cannot provide a solid economic foundation. The rally can go further, but is doomed to fail in the end as reality blows away the flimsy wall of money. Real economic prosperity requires real economic growth.

Navigating the Labyrinth

When I listen to the arguments of the bulls, I can see their points. When I listen to the bears, their ideas make sense too. In order to be profitable over the next few years, investors are going to need to understand how the 3 walls we’ve described today are affecting global markets.

So far, the bulls have had the upper hand. Traders have climbed the Wall of Worry, shaken off the Wall of Debt and embraced the Wall of Money. But the bears may have their day yet. The Wall of Worry is getting larger. The Wall of Debt is too. And the Wall of Money may not hold up forever.

How are you navigating this 3-walled maze?