Stock market volatility is the new norm. What is going on in global stock markets? The Dow Jones Industrial Average (DJIA) closed on August 1, at 12,132. By Friday, August 12, it had plummeted to 11,269, down 7%. En route, it collapsed to 10,809 on August 8, jumping to 11,239 on the ninth, and on the eleventh, fell again to the period’s low of 10,719, or 11.6%.
Stock Market Volatility: The New Norm
Why is this happening? Are circumstances changing so fast? What meaningful variables altered between the fifth and twelfth, to cause this stock market volatility? This wild roller-coaster ride.
Pundits have proposed specific reasons for the stock market volatility. The suggest America’s credit rating downgrade, sustained high unemployment, and declining consumer confidence, contribute to these wild swings. I will look more generically, and then suggest an approach for individual Registered Retirement Savings Plan (RRSP), 401Ks, or equivalents, to help investors ride through this storm.
Stock market volatility causes fear and uncertainty. Market players hate uncertainty. During volatile periods, investors will search everywhere for hope. And when they see a glimmer, investors rush in but exit when the market dips again.
Besides, investors are like sheep. When the market rises steadily, investors follow other investors and buy, just because others are buying. This herd mentality leads to market bubbles such as the dot-com debacle. Then, folks realized late that they had overpriced excessively, stocks such as Nortel and Yahoo!.When these bubbles burst, a massacre begins. Panic and irrational selling start on a massive scale, creating a value investor’s dream.
Generically, what is happening today? Uncertainty prevails in all leading economies. European economies are in trouble. Major needed surgery in Greece will cause them to stagnate for years as they deal with results of prior heavy government involvement in the economy. Besides Greece, the EU rescued Portugal and Ireland. Now markets are worried about France, one of the earlier rescuers. And let us not forget that in the UK, the coalition government has a daunting task to sort out that messy economy.
And then, there is the USA. Spending beyond its means, divided legislature, in the midst of electioneering. This situation is a perfect uncertainty formula. So, fasten your seatbelts and be ready for a bumpy ride for the next couple of years.
Response to Stock Market Volatility
What can individuals do in this investment environment? Be cautious; reject the herd mentality. Specifically, here are a few steps that might help:
- Don’t invest if you have consumer debt or a mortgage. Pay off these first and then start a capital fund.
- Avoid day trading; not only is it stupid, but it is insane. Stop, if that’s what you are doing.
- Develop a goal and plan. Why are you investing? Your reason will decide your investment strategy. Review the plan yearly or when conditions change. My preferred strategy is to buy equities with a long history of solid fundamentals and dividend-payment. I hold them, review the fundamentals regularly, and I am not concerned with market fluctuations, provided the long-term fundamentals remain. Remember, you lose, or gain on sale only, not when markets fluctuate!
- When your investments’ fundamentals change, confirm your strategy, and sell even at a loss. The market could be down for several years, like the Japanese market which has been below its bubble highs for more than two decades! See the chart below.
- Avoid flavor of the month investing like gold, which has no intrinsic value but rises during these uncertain periods.
- Be proactive; know your risk profile, understand your portfolio mix, and think long term. Don’t be influenced by generic asset mixes; you are unique, and your mix should fit you at your life stage.
- If you are in the retirement red zone, seven years to retirement, your goal must be capital preservation.
- Don’t panic, though there is a point where, as in Japan, the market might not recover quickly. Still, your focus must be on your goals and plan. They must be up-to-date and fit your needs and your risk profile.
One key factor that we forget is that USA consumer spending is about 70% of GDP. Consumers were hurt badly in the Great Recession. Today, they will not rush to spend recklessly as before. Therefore, in economies like the USA that is not producing jobs, we should expect consumers with jobs to save, not spend as earlier.
Therefore, Global and USA economic growth will be slow–logical result of earlier over exuberance that led to the most recent bubble. Beware; more government stimulus sounds like good politics, but merely will grow public debt rapidly. It will not improve the economy. Patience must be our mantra!
For more investment basics, read chapter six of The New Managing God’s Money-The Basics.
© 2011 Michel A. Bell