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Investing Specialists

The Market That Wants to Believe

Given the volatility in the Middle East and the many unknowns in Japan, the assumption of a quick return to normalcy is a relatively bold expectation.

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Given unrest in Egypt (then Libya and Bahrain), gasoline close to $4 per gallon, and an unfolding disaster in Japan, it is nearly impossible to fathom that the S&P 500 is still within 4% of its recovery high of Feb. 17, 2011. At same time, first-quarter GDP estimates have moved from close to 4% to the range of 2.5%-3.0% and inflation has accelerated, yet the market continues to hang in there.

The indicators provided more of the usual news this week--real estate stuck in a rut, inflation accelerating, manufacturing burning up the track, and unemployment claims data limping back toward long-term averages. The consumer has not given up hope yet, either, as weekly chain-store sales continued to show year-over-year growth in excess of 3%, despite some incredibly tough comparisons with a year ago. The International Council of Shopping Centers weekly index is now at its highest level of the recovery. It seems to me that both the market and the consumer have become inured to all the world's crises.

From Panic, to Complacency, to Renewed Panic?
The stock market's reaction is not atypical to what has happened during past periods of economic difficulties or natural disasters. At the start of a crisis, the market does what it does best: It panics. Sell now, ask questions and get the details later. This time was no exception. The market experienced several drops of more than 100 points this week as the Japanese nuclear situation worsened. Given all the uncertainty, those market drops are not unjustified. Typically, when the worst-case scenario doesn't occur instantly, the market often flattens out or perhaps even rebounds. After the reactors in Japan didn't melt through the center of the earth and there were reports of many unharmed businesses, markets rebounded sharply later in the week. Following the panic, complacency settles in. Then, over time, as a full picture of the triggering event becomes clearer, markets often sell off more dramatically than the initial panic.

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.