September 24th, 2008

Has the Market Priced in a Bailout?

For stock traders and investors, one of the most important aspects of the discussion about “TARP”, the Troubled Assets Relief Plan, is what the impact of passage will be on the market. Of course, there are the questions of how we’ll pay for all this? What is happening to our competitiveness in the world economy? Will we have rampant inflation or suffer a serious and unfamiliar case of deflation?

These questions are all equally unfathomable and beyond the ability of the average investor to influence, let alone understand, the outcome. But the stock market is like to a real-time “voting machine”; participants continually making their opinions, assessments, evaluations known through their buying and selling decisions.

To navigate these rough waters, each of us must attempt to anticipate what the market’s reaction might be. To do that, we have to answer three questions:

  • Does the market expect passage?
  • Have the majority of investors accurately priced in what they believe the outcome will be?
  • What might be the effect if the outcome is different from these expectations?

In short, will the most likely outcome be a “relief rally” or a continuation of the decline as the market then shifts to incorporating the “full economic impact?”

My wife (an excellent trader in her own right) and I debate the impact of passage on the market. She believes the Dow 30 Index will bounce 500 points as it did after earlier recent bailouts on passage of the legislation and then hover at that level for a few weeks before falling again.

My feeling is that the answer to the first two questions is affirmative. The market now assumes passage, passage is priced into current market levels and actual passage will be anti-climatic. The principal outcome, in my opinion, will be continued downward trend because the economic reality will be viewed negatively rather than positively. The focus will shifting away from “we’re going to do this but only discuss how” to “we’re going to do this but with what disruptions and at what cost”.

Could you help us solve this “marital dispute”. What do you think is going to happen?

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