Is the glass half full or half empty?

Trying to figure out which direction the stock market will go has gotten to be very difficult, even for the so-called experts. With the defeat of the bailout of the "big 3" auto companies in the Senate on Thursday, many expected a massive drop off in North American stocks on Friday. So what happens? They all finish in positive territory. While I'm sure that the announcement by Dubya (using TARP $$$ to bail them out which seems to defeat the purpose of the term TARP) had some positive effect, it makes you wonder whether anyone really knows what is happening.

Is there a point where things get so bad, it’s good? Yes. In every capital market there are essentially two drivers – fear and greed. Not to keep harping on this but as Warren Buffett once said "Be fearful when others are greedy and be greedy when others are fearful". Right now, fear is winning. Capital market volatility, tight credit conditions, broad economic concerns, and murky outlook for companies have caused a significant shift in asset allocation – away from all things ‘risky’ (i.e. equity and credit products like corporate bonds), into all things ‘secure and safe’.

The continued demand for government bonds with little to no regard for the ultra-low yields is a clear sign that investors are now significantly more focused on the return of their money, than the return on their money. Companies and households have forgotten about profit maximization, and have become preoccupied with minimizing debt. This is a primary reason why interest rate cuts have yet to stimulate increased economic activity - simply put, no one is interested in accumulating more debt.

Here is a fact that I thought I misread the first time. In Friday's Globe & Mail, Barrie McKenna reported the following - For more than a generation, Americans have steadily piled on trillions of dollars worth of debt to buy ever-larger homes and cars. But something remarkable happened this year as the economy sank into recession and financial crisis. The long credit binge came to a screeching halt. New data from the U.S. Federal Reserve Board show that in the three months ended in September, U.S. households cut their debt levels for the first time since 1952. And for the first time on record, Americans paid off more mortgage debt than they took on.

The shift in assets that has taken place over the last several months have meant that ‘good’ companies have been sold right along side the ‘bad’ companies at depressed prices.

This broad-based and indiscriminate selling has created additional downward pressure on the stocks –and so a cycle of prolonged downward pressure on stocks plays out. Despite the best intentions to buy low and sell high, many have done just the opposite, essentially cashing in losses to invest in assets with little to no expected return. While no one can pinpoint the exact moment, as time wears on there will be a shift as fear begins to subside and investors (perhaps timidly at first) begin to seek out a return for their investments. When that happens, the reverse flow from fixed-income products and cash will create an abundance of buyers in the equity market, rewarding those investors who resisted the temptation to abandon their well diversified, long-term investment strategies.

Ultimately, the next few weeks and months will determine who wins the "game" and who loses. Which game you may ask?