What is going on with the markets?
You may have noticed recently that stock and bond markets have suddenly become more volatile, more prone to ups and downs. Until recently, volatility has been at an all-time low. How do we measure it objectively? Well, most of us are aware that the US markets recently dropped by more than 10 percent. The objective measurement, or the best one we have, is an obscure index called the VIX, sometimes referred to the “investor fear index.”1 The VIX measures volatility by gauging interest in options that investors buy or sell to protect themselves from market ups and downs. Why is it relevant? Though not perfect, it is the best measurement we have for understanding volatility and market risk. Interestingly, some investors bet that low volatility is here to stay and that may be one factor in the market’s recent downturn. When so many investors tried to pile into this low volatility prediction, something had to give. (Think college students piling into a VW Beetle.) When investors started trying to get out of this trade, the exits were suddenly blocked, inducing panic.
So, what else caused the downturn? We are still figuring that out, and here are a few things to consider:
- The US markets have been moving mostly up since March of 2009. That is when the market finally started to turn around after the financial crisis of 2007-08. Except for a few interruptions, it has been nearly straight up since then.
- Inflation is finally starting to move up and so are interest rates. After the financial crisis, the Federal Reserve or “the Fed” as it is sometimes called, pulled out all the stops to try to get the economy up and running again including taking short-term interest rates to zero and buying up the supply of available government bonds.
- Concerns are that the economy will heat up too fast and the Fed will have to raise interest rates aggressively. The Fed did this in the early ‘80s with not so good results. Borrowing costs got very expensive as anyone who tried to buy a house in the ‘80s knows.
- Historically the market does ok, even in rising interest rate environment, but only to a point. Many are fearful that if the Fed has to raise interest rates too fast, they will put the economy into a recession.
- The value of stocks has been going up and up and may have gotten ahead their real value. The short version of this is that stocks have gotten expensive. There are all sorts of ways to measure this, but I will leave that for another day. With prices going up since March of 2009 and growth staying in the 2-3% range something has to give.
- There are a host of other factors, and an important one to consider is that much of the trading done in the markets today is done automatically by computers that have instructions to sell or buy on certain conditions. When markets go down, they tend to sell at the same time and there are a limited number of buyers to step in. This just makes the decline that much faster.
What not to do.
The list above demonstrates just a few factors. Many of the factors that caused the correction may remain unknown. So, what do you do? Let’s start with what not to do. Don’t panic. Don’t sell everything you have in your 401k or other investment account and put it in cash or money market or gold or Bitcoin or bury it in the backyard. Why? Because you compound the losses by selling when everyone else does and not getting a fair price when you sell. Think about trying to sell your home in 2007-08. Then you are on the sidelines when the market goes up so you miss the recovery. This is the double whammy of panic selling. Also, investors often sit on the sidelines for a long time before re-entering the market until the market looks safe again. This may be exactly the wrong time, setting you up for another sell-off. This is one of the main reasons many investors fail to earn the return that stocks provide. They get in and out of the markets and make things worse.
What to do.
Take this an opportunity to take stock, so to speak, in your investment strategy. Did the market downturn keep you up at night wondering if you would be able to retire when you want, send your children to the school they got into or take that vacation you were looking forward to? If you answered yes, let’s reassess your situation. If this last market downturn made you nervous, reduce your risk, but do so carefully and thoughtfully. Many of us fear missing out on the markets and put more in stocks then we should. Tales at cocktail parties of how much so and so made on their investment in FAANG stocks (journalistic lingo for Facebook, Amazon, Apple, Netflix, and Google) are probably overblown. Also, people rarely tell you about the stocks they bought that didn’t do so well. Turn off the noise in media and at your neighborhood watering hole and develop your own strategy, one that works for you and allows you to sleep at night. If we can help, please reach out to us. We do have a tool that evaluates your appropriate level of risk and you are welcome to use it without cost. Just ask us how.
I’ll close by saying, Thank You. You mean the world to me and I enjoy every minute, well nearly every minute, that I get to talk to you, plan with you, strategize with you and be a contributor to your success and to Living the Life of Your Dreams. Really. I live for this.
See you soon,
David
