Point for Discussion
The stock market can be and has been quite volatile, and the reasons for this range from the emotional to the rational, but always in response to something – whether tangible or intangible. Could we as investors have greater control over the volatility?
Our Points of View
People, of course, want the value of their stocks to grow, and do what they can to stabilize their portfolio, whether through diversification of companies or types of investments. However, I find it concerning when the market declines – not because of a change in any company’s performance – but because there “may be” a rise in rates by the Fed, or because there “may be” a reduction in an employment measure that comes out in a few days, and so on.
We are actually hurting our own investments by pre-reacting to something that hasn’t even happened. Couldn’t we then, avoid some volatility by not pre-reacting? In other words, if we could somehow agree to maintain the status quo, wouldn’t we retain more of the value? Sounds idealistic, but is it?
Here’s one way this might actually work. Why couldn’t stock prices be negotiated to a fixed value, which investors buy into? Companies get the capital to invest and use now, and people get peace of mind so they can plan for retirement without the roller coaster. It’s done with everything else (e.g., insurance rates, prescription prices, and so much more). Why can’t it work for stocks?
As a related example, does the price of oil have to be so volatile? Isn’t there a price per barrel at which the oil companies are satisfied and we, as consumers, pay a reasonable price for gas every day? Why does it have to fluctuate so much? If the companies know what the price per barrel would be ongoing throughout the year, and we, as buyers of gas, know what we would be paying at the pump, everybody wins, and volatility is reduced. Oil companies, across countries, are negotiating anyway to influence supply and demand, and ultimately, the price. Why not have a steady price that works for all?
I believe we can think differently about the market to better manage the volatility.
I agree with Laurie that the volatility in financial markets makes me uneasy, even queasy at times. But I am trying to be a bit more pragmatic about it. I actively manage my IRA these days. I spend a lot of time watching market movements and I keep telling myself that I will know when it’s the right time to get out. I got caught twice in February when the markets dropped significantly in a short period of time. My gut says that the economy is booming right now, jobs are available, wages are increasing, and corporations are experiencing ever-improving profits. All good, right?
Not so fast. Rising inflation and interest rates are going to impact the markets as well. And there will be a point at which the increasing rates will negatively impact equity values. There seem to be a variety of opinions out there on how high the interest rates can go before stock prices are impacted. Bond yields in excess of 4% will absolutely impact the stock market. Some analysts believe the correction could be in the range of 20 to 25 percent.
We saw a preview of that early in February when the markets experienced a 10 percent correction. This was frightening to many investors. I’m sure there were many that felt this was the big correction and sold their holdings in order to prevent a larger loss. I did the same thing back in 2008 – 2009 during the Great Recession. I wish today that I had not done that. This time, (after telling my Financial Advisor I would know when to say when), I held on to all of my investments. I actually invested further. And then anxiously watched markets wondering if I was really smart enough to know when to react.
Is the market driven by emotion? Perhaps. Many believe that they need to cut losses in order to protect their nest eggs. I fully understand. But most equities are majority owned by financial institutions and hedge funds. Many of these entities set programs to sell, if an equity price drops to a certain point. Once the snowball starts rolling downhill, it’s really hard to stop. This just drives pricing down further. It also appears that investors can now “bet” on the volatility indices. These new financial instruments caused some of the problem as well by exaggerating the market movements.
Stock prices are anticipations of future value based on current performance and the outlook for the future. Corporations have been exceeding expectations for earnings, following that with a weakened outlook for the future. I have seen specific stock prices drop by as much as 15 percent immediately following the release of this information to the public.
How do we manage the volatility? The best way is to fully research prior to investing. If you fundamentally believe, based on research, that an investment has potential to grow, market movements should not create so much anxiety. Stock is a long term investment. If you need the money in less than two years, maybe the stock market isn’t for you. Diversification is very important. A balanced portfolio can serve you well over time. A mix of stocks and bonds can help too.
Markets are impacted by many non-financial events too. Geo-political events could throw conventional wisdom right out the window, making this all feel less predictable. There are trained professionals making a living off of understanding markets and financial instruments, and they don’t always get it right either.
Our Question for you
What do you think could be done, if anything, to minimize the volatility of the stock market?