Friday, April 17, 2009

V=sqrt (2W/CdρA)

Investing at the geek level is full of greek letters and Newtonian concepts like inertia and momentum. For the past month the market seems thoroughly beguiled by the physics concept of terminal velocity. That moment when an object is no longer accelerating in its descent has captured the analysis of the talking heads.

What bothers me is the giddy tone. Falling no more rapidly does not by any stretch of the imagination mean the object in question is now flying. It is simply not going to hit the ground at any greater speed than present. A significant SPLAT! may still be in the cards. I agree we have decelerated our decline, but I am not yet prepared to accept that a reversal is going to be immediate and prolonged.

The term of art bandied about now is, “second derivative trade.” Objects do not fall at the same rate through the atmosphere and the stock market behaves similarly. Greater velocity occurs because of a number of factors and as these factors change, so too does acceleration. Weight is a factor, i.e. gravitational force. Surely the Dow at 8,000 weighs less than the Dow Industrial Average at 14,000. It makes sense. Gravitational pull is proportionately less.

Two other aspects of speed of decent are drag coefficient and gas density. We’re certainly lower in the atmosphere from the past lofty levels so air density should be greater and slow us down a bit. The final rate impacting factor, drag coefficient would be earnings. At the moment earnings are still coming in at a very streamlined level. In other words, there aren’t any. A few good earnings reports will be the parachute to truly slow the descent to a gentle landing.

Some investors are rushing to buy on the basis that the speed of decent has slowed. In the spirit of, “if you are in a hole the first thing to do is stop digging,” the market action is certainly positive, but caution is still called for. Investors should have been beginning to rebalance earlier this year when technical signs began to flicker green, but there is still a lot of work to do and no one needs to think they’ve missed it.