5 reasons not to overreact to the stock market volatility
It’s Monday, the market just opened and the Dow is down 1,000 points. Yikes! You turn on the TV and the news is reporting that the downturn is due to a global slowdown, China, Greece, Iran, ISIS, the Fed raising rates, student loan debt, etc.
It never stops. There is always a gloom-and-doom “reason” being reported explaining why the market is turning down. However, as we have written in these pages before, news events should rarely dictate your investment strategy when it comes to the markets.
What is currently happening is normal, and you shouldn’t overreact to it. Here are five reasons why.
1. Corrections are frequent and normal
Since 1928, there have been over 90 corrections of 10 percent or more. That works out to about one correction every 11 months. In Chart 1, you can see that from the recent low in 2009, multiple corrections have occurred over that past six years that range from 5 percent to almost 20 percent. These are all part of a healthy trending market.
2. Don’t be like “Overly Paranoid Rob Lowe”
Yes, from the DirecTV commercials. You see, “Overly Paranoid Rob Lowe” sells at the bottom and buys at the top of the markets because he makes decisions by emotions instead of a disciplined strategy. It’s no wonder that over the past 20 years, the average annual return for an equity mutual fund investor was only 5.89 percent, while the S&P 500 return was 9.19 percent.
3. An economic recession is unlikely
This is mainly due to interest rates being low and the yield curve steep. Chart 2 shows us every recession in the U.S. since 1956. What they all have in common is that the Federal Reserve has aggressively raised interest rates prior to the recession. As you can see, rates currently remain near 0 percent, and even if the Fed decides to raise them, its members have said it will be minimal and likely not aggressive in nature.
4. Because your financial plan and risk-management strategy are in place
“What is that?” you ask. A realistic and relevant financial plan with a sound risk-management strategy. You don’t have one? Then hire an advisor who will help you build one. If you have an advisor and still don’t have one, then fire them immediately and find one who will.
Investing without an overall plan and risk strategy is much like playing offense with no defense. If you have trouble sleeping at night, then your investments don’t match your risk tolerance. You can easily fix this problem with the right plan in place.
5. What the media says and what is actually true are rarely the same
Which is a sexier headline? “China is committing economic warfare by devaluing its currency and selling U.S. Treasuries,” or “The liquidity the Federal Reserve is providing continues to raise and support asset prices.”
I may have dozed off while writing the second headline. Yet that explains much more about why the stock market is behaving the way it is than what is going on in China. When investors react to headlines with the powerful emotions of fear and greed, they tend to influence the markets over the short term. Longer term, it’s the fundamentals and economics that dictate ultimately where the market is going. Always remember, the media sells airtime and advisors sell advice.
Volatility in many ways is your ticket of admission to investing in stocks, which historically has provided positive returns outpacing inflation. Corrections frequently happen. The difference between a correction and a bear market downturn is the magnitude and duration of the move.
We believe the weight of evidence today does not forewarn a bear market. However, stocks have had a long run and certain risks have increased, so a conservative stock investment strategy would be prudent, in our opinion. If we see a deterioration in the indicators we follow, then we will use our disciplined approach and adjust accordingly.
Having a plan with a risk management strategy keeps us from overreacting to volatility by eliminating emotional decisions, taking advantage of opportunities and helping to limit downside losses.