The stock market in 2009 has put investors through just about every kind of emotion possible: frustration, fear, elation, hope, depression and relief come to mind. I’m sure there are more, but you get the picture. When the market starts the year by diving 30% in a little over two months, as it did through March 9, and then turns around and gains north of 60% the next eight months, there aren’t many emotional stones left unturned.

Now, as the Dow has stalled out in recent weeks north of the psychologically-important-but-fundamentally-irrelevant 10,000 threshold, it seems the dominant emotion amongst investors today is trepidation. A general malaise that the market has come too far, too fast, and we are therefore destined for another steep downturn. The media is teeming with so-called experts who subscribe to this worldview and help keep this feeling of trepidation front-and-center in the investor psyche.

I think all of this handwringing requires deeper analysis, because there are two points to consider that are being glossed over in the discussion:

First is the obvious: Of course the stock market will go back down, because, in the short-term, the market’s behavior resembles more a yo-yo than a straight path upward. The trend line of the market over the past year – a huge dive down and then a huge climb back up – is historically atypical. The more normal behavior for the market is a lot of short-term bouncing around within the longer-term march upward. Given that we have seen gains of between 60% and 80% in most major asset classes the past eight months, no one should be surprised if the market experiences a downturn in the months ahead.

That doesn’t mean, however, that the market is doomed to repeat its swoon from last year. Bear markets (defined as a 20% market decline) are a fact of life in the stock market, but the market panic that began after the collapse of Lehman Brothers in September 2008 is not. Such events are the equivalent of a 100-year flood in the capital markets. They are extreme events of rare frequency.

The second point that bears further analysis is the assumption that the gains we have seen are somehow “invalid,” the short-term result of another bubble that is doomed to burst. But the current psychology of the market is one of doubt and disdain, and bubbles aren’t born on skepticism. Remember back in 1999 when all you had to do to get rich quick was get in on a dot-com IPO? When making a triple-digit gain in a single day was not unusual? When the experts said we were in a “new era” when earnings didn’t matter anymore? That is what a bubble environment is like. Bubbles are born, not just on optimism, but on pie-eyed euphoria and a complete detachment from risk. And that is a long way away from the skepticism and doubt many investors have today about the sustainability of the current bull market.

As we said in our client letter last month, perhaps history will show that the overreaction in all of this was not the recovery of the past eight months, but the end-of-the-world panic that preceded it. If that proves to be the case, then a return to the stock market levels prior to the collapse of Lehman is not only plausible, but actually just makes sense.

Back in July I was reading an article on the Wall Street Journal’s web site that I must admit I found amusing. It was an analysis of the sudden and dramatic rally the stock market had recently experienced, a period in which the Dow Jones Industrial Average gained 10% in only about a week.

The article was amusing because it contained lots of quotes from “experts” who were confounded by the rally. One trader, for example, remained steadfast in his contention that market sentiment on Wall Street was still negative, but said had no choice but to be buying because of all these pesky buy orders he was being flooded with. This is the kind of myopia that sets in when you work on Wall Street and believe it is the sentiment of a handful of traders, as opposed to the intentions of billions of people all over the world, that determines the direction of the market.

The comments from the experts, however, were nothing compared to the handwringing that was going on in the follow-up comments that readers had posted about the article. One woman was calling for a “supercop” regulator who could prevent these “bubbles” from forming in the stock market again. (Presumably she would like a government entity to approve who gets to buy stocks and who gets to sell them.) Another was haranguing all the “idiots” who were buying into the market when the economy is still in such bad shape. There were pages and pages of these comments, and almost all of them were communicating the same plaintive wail:

“The market isn’t supposed to be doing this! It doesn’t make any sense! All the news is bad – it’s supposed to be going down!”

For the past ten months, it’s been easy money to bet against the stock market. All those folks who did so looked like geniuses, and were quick to guffaw at those who were staying put in a market that was stuck in reverse.

Now they are experiencing the other side of the coin, and they are finding it none too fun. They are railing against a market that has taken off just when things seemed the bleakest, claiming it must be a temporary upswing on the way to fresh lows at some point down the road.

They look at the nearly 50% gain the market has logged in only a few months, which they have completely missed out on, and tell themselves the market is “overbought.” But they are unaware of the dramatic gains that occur on the other side of historic bear markets. Like the 47% gain the S&P 500 posted in only eight months coming out of the 1973-74 bear market. Or the 50% gain the market saw in the months coming out of the 2000-02 bear market.

I don’t pretend to know where the market is heading in the short term. But there are a lot of folks who did pretend to know and made their investment decisions accordingly. And right now they are paying a heavy price for their hubris.

One of the challenges I face as an investment advisor is that no matter who is President, there is always some portion of my client base that is tremendously unhappy with the current political administration. It then falls to me to park my own ideology at the door and keep whichever group is feeling disenfranchised from letting their political frustrations seep into their investment decisions. 

From that perspective, it has been interesting these past few months watching my Republican clients waving at my Democratic clients as they change seats on the doom-and-gloom train. One of the common complaints I have heard from the former group is a belief that the increasingly activist role of the government in regulating the free-enterprise system will spell doom for the stock market.

On that front, the research folks at Dimensional Fund Advisors recently passed along to me some interesting performance numbers for stock returns of the world’s developed countries in both the past 10 and past 39 years ending in 2008. The data shows that the line between free-market policy and stock market performance is not as clear as many people believe: 

It is interesting to note that, despite the pro-market nature of most U.S. political administrations the past four decades, the returns of the U.S. stock market were in the rear of the pack of the world’s developed nations. Meanwhile, countries such as France, Sweden, Denmark and Canada, whose governments were far more activist in their respective economies during this time, significantly outpaced the returns of the U.S. market.

This is not an endorsement for socialism, of course, and you can draw whatever political conclusions you want. The investment implications, however, are clear: Capital flows to whichever corners of the globe are perceived to provide the most bang for the investment buck, and that investment capital is agnostic about political ideology.

Scanning the day’s media reports after Monday’s monstrous market rally, I was bemused by the number of analysts who continue to inform us, the unwashed masses, that this is a “bear market rally”, meaning that anyone who thinks the market downturn is over is a fool. The chutzpah it takes to presume you know the intentions of billions of individual and institutional investors around the globe is staggering, but such is the nature of Wall Street.

One particular analyst’s comment was especially amusing to me, however, because I think it was perhaps more honest about his utter cluelessness than he really intended.

“I think this is still a bear-market rally,” he said. “But if we move above 8,000 and are able to hold that level, I may have to change my opinion.”

The plain-English translation of this would be: “I’m saying we’re still in a bear market. Unless it turns out we’re in a bull market. Then I’ll say we’re in a bull market.” This is akin to the weatherman looking out the window to give you your weather forecast. Thanks a lot, Dr. Scoop.

This reminds me of the old saying, “Opinions are like bellybuttons. Everyone has one.” (Technically that is not the exact part of the anatomy referenced in the ol’ saying, but I have to keep it clean here…) The point being that if a reporter calls an analyst and asks him what he thinks of a market rally or market decline, he’s going to offer an incisive opinion because it is going to read a lot better than if he says, “Don’t have even the vaguest idea! How about you?”

And if you work on Wall Street, your opinion is going to be massively influenced by the groupthink of all the traders and analysts and hedge-fund managers you are surrounded by 24/7 at your Exeter reunions and yacht christenings. You may have noticed, however, that the Wall Street mindset is not exactly representative of what the rest of the country is collectively thinking at any given time. It’s sort of like Washington, D.C., but with nicer suits.

When you throw a few dozen of these opinions together into a Wall Street Journal article or CNBC segment, it starts to seem like these people really know something about where the market is heading. But if you go back and look at their comments from the past, like in 1999 (“Buy!”) and in 2002 (“Sell!”) and in 2007 (“Buy!”), you will find that very often they know the exact opposite of “something”, which is, of course…nothing. And if you get them in a corner at a cocktail party away from the microphones, they might even tell you that.

What makes this crowd so dangerous is that they aren’t afraid to pretend otherwise, and they are all too happy to perform their Gypsy Fortune Teller act whenever the media asks them to. That’s why the few beacons of light like John Bogle and Warren Buffet shine through the white noise so brightly – because they are some of the few market gurus who will look the general public straight in the eye and tell them they have no clue about the near-term direction of the market, and no one else does either. They are the voices of reason in a sea of insanity.

There is another saying about investing that I particularly like: “Stocks climb a wall of worry.” When you look at the market’s long-term history, that may be the most accurate observation anyone has ever made. There is always plenty to worry about, and sometimes those worries affect the market in the short term, and then all those “experts” seem to be clairvoyant. But then, eventually, stocks begin to climb that wall of worry and don’t look back, and all those who let the day’s supposed experts alter their long-term investment strategy are left in the dust while the market moves on inexorably without them.