Education >> Investing Your Money

Volatility Has Returned to the Stock Market

It’s ba-ack!

Yes, like the ghosts and goblins in the sequel to that popular ’80s flick Poltergeist, volatility has returned to the stock market. And just as everything turned out fine in the movie, we’re similarly confident about the market. But there are important details you should know. This update will tell you what we are doing — and what you should do.

2010 began as good as 2009 ended. In the first 16 weeks of the year, the S&P 500 Stock Index had gained 7% — an annual pace, if sustained, of 23%. But that pace was not to be; as of Friday afternoon, the S&P had fallen 11% from its April 23 high, and it’s down 2% since January 1.

The best way to explain why the stock market has declined is by relating a phone call I received from a client last week. “What do you think of this crisis?” he asked. “Crisis?” I replied half-jokingly. “You’ll have to be more specific. Which crisis?”

Indeed, so many headlines are being produced these days that it’s hard to keep track of them all.  Greece can’t pay its bills, the Euro is falling, Goldman Sachs is accused of fraud, there’s an oil disaster in the Gulf, floods in Nashville, volcanoes in Iceland and we barely avoided a bomb attack in Times Square. Two weeks ago, the Dow fell nearly 1,000 points in less than 10 minutes — and all the while unemployment and foreclosure rates remain high, while real estate and stock prices remain far below their highs of three years ago. And let’s not forget the federal deficit and debt, and continued fears of inflation and higher taxes.

Small wonder that many people are spooked. Add to that the fact that many investors are battle-weary, still fatigued from the investment losses they sustained during the 2007–2009 credit crisis. Nobody wants to experience another round of market declines.

So please read this update carefully, for it contains four important messages that are vital to your investments.

First message: We believe that the markets are likely to experience volatility for a while. However, it is crucial that you understand the difference between volatility and declines. You see, there are three kinds of market environments: bull markets (where prices are rising), bear markets (where prices are falling) and volatile markets (where prices are fluctuating). 

We are experiencing that last market environment: volatile markets. Although it’s true that prices often fall during periods of volatility, it’s equally true that prices rise as well.  The funny thing is, people only complain when downside volatility happens; nobody ever complains about upside volatility (no one called us to discuss the stock market’s performance during the past 12 months, for example, while the major indexes were rising 75%, according to The Wall Street Journal). Yet, you can’t have upside without downside — and neither serves as a reliable predictor of what will happen next. Volatility, stated quite simply, is what it is. It is nothing more.

This leads to our second message: Do not fear a volatile market. Just as a rapidly spinning coin is as likely to land heads as tails, there is no way for you to conclude that today’s volatility will result in long-term market losses. Indeed, it is equally likely that today’s volatility will be followed by the continuance of the bull market that began in March 2009. (And, later, we’ll explain why we believe that is in fact the more likely result.)

Our third message: Volatility is a child of uncertainty — and the more uncertain investors are, the greater the swing in prices. Because it is possible that volatility could last a while — days? weeks? months? — you need to be emotionally prepared for such an environment. Many investors can recall with angst and dismay the volatility of 2007-2009 and feel they could not stomach such events again. Others are retired and withdrawing income from their accounts and are thus reasonably concerned about the impact volatility could have on their income and the safety of their portfolio. Still others plan to spend some or all of their money within the next year or two. Volatility is the enemy of short-term liquidators for the simple reason that you don’t know what the value of your account might be on the day you plan to sell your shares.

For all these people, it is appropriate to consider carefully both your finances and your emotions. It is possible that a shift in your portfolio is warranted — not because we fear that the markets might fall in value but because your portfolio must reflect your individual situation. The strategy you follow must be in your best interests, and being emotionally unhappy with your investments is as bad as being financially  unhappy with them.

Sometimes, people get emotional about their investments after media exposure. Headlines and pundits are in the business of scaring people with BREAKING NEWS! and the controversy, confrontation and confusion associated with this can lead many to fear the worst. If the news causes you to be upset, then stop watching, listening and reading. You’ll be better off.

For all the reasons cited above, a few clients have shifted to portfolios that feature lower volatility than their previous portfolios. If you haven’t spoken with your planner lately and you have concluded that, emotionally, you’re better off reducing your portfolio’s exposure to volatility, give your planner a call.

Our fourth and final message is perhaps the most important one: For the overwhelming majority of our clients, there is no reason to have any doubts at all, and you need take no action. (Remember that all of the financial planners at Edelman Financial, as well as Jean and I, personally invest in the Edelman Managed Asset Program® just like you do, and none of us have made changes in our personal portfolios because of current events.) This doesn’t mean that we aren’t prepared to take action for you (as well as ourselves) should that become necessary. Indeed, we have developed contingency plans for a wide array of possibilities, from hyperinflation to currency devaluation to higher interest rates to massive declines in the stock market. But just as people who own umbrellas don’t use them on sunny days, we regard it as premature to implement any of those strategies — but we have the umbrellas anyway and are prepared to use them if necessary. At present, however, we see no justification for implementing such measures.

Indeed, although we acknowledge that our nation is facing some very serious issues, we also know that there is a huge difference between our current environment and that of three years ago. You should understand this point as well.

As we entered 2007, the nation was facing unsustainably high real estate and stock prices. Millions of people had purchased homes they couldn’t afford by obtaining mortgages they couldn’t repay. The economy had expanded largely on credit and overly optimistic predictions of continued low interest rates and unemployment — and none of those predictions proved correct. America’s largest corporations were losing money, and some of them — Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac, General Motors, Merrill Lynch and AIG — either went broke or had to be rescued. Looking back, we can see that the resulting declines in stocks, real estate and interest rates were not only necessary, they were the inevitable results of an economy gone wild.

The environment today bears little resemblance to that of three years ago, however. Stock and real estate prices are far more fairly priced.

There’s more:

• Unemployment rates are falling — as of April, only six states have higher unemployment than they did in March, according to the Labor Department.
• Inflation is running less than 1% annually — a 44-year low! — says the Federal Reserve Board.
• Mortgage rates have dropped to the lowest level of the year, reports Freddie Mac.
• Foreclosures have declined (the first annual drop in more than five years), says RealtyTrac.
• Mortgage delinquencies have plateaued, observes the Mortgage Banking Association.
• The Architectural Billings Index — a predictor of the construction and architecture industries — is now at its highest level since August 2008, says the American Institute of Architects.
• Dell reported a 52% increase in first quarter profits compared to a year ago. In fact, according to Bloomberg, nearly 80% of all the companies that comprise the S&P 500 beat analysts’ profit estimates.  Many have performed so well that they’ve increased their outlook for the rest of this year.
• America’s big corporations are sitting on nearly $1 trillion in cash, according to The Wall Street Journal.  Five companies — Microsoft, Google, Cisco, Apple and Intel — have enough money between them to completely pay Greece’s entire $105 billion debt! (Rather than bailing out Greece, you can expect these companies to go on major acquisitions spending sprees, which is great news for the economy.)

Thus, rather than be upset about current volatility, we have come to accept it and view these periods as opportunities, for today’s prices are 11% below their recent highs — meaning that, once again, Wall Street has put stocks on sale! In other words, this is the time to be adding to your investments, just as the nadir of the credit crisis proved to be an outstanding time to invest. (Even those who lack the funds to add to their accounts are actually “buying” these days, thanks to our strategic rebalancing program, which periodically sells higherpriced assets and buys lower-priced ones, potentially improving your investment returns while lowering your investment risks.)

If you’re working, you need to continue contributing to your retirement plan at work in addition to adding to your accounts with us. If you’re not already contributing the maximum amount that your plan permits, start doing so immediately. We generally advise that you place your new deposits into stock mutual funds and make sure your current balance is properly diversified. (If you’re not sure how to manage your retirement plan assets, call your planner.) If you are retired and receiving income from your investments, it is equally important that you maintain a diversified portfolio.

Also be certain that you have sufficient cash reserves — at least one year’s worth of spending. If that’s a challenge, your planner can talk with you about ways to increase your reserves. The worst scenario would be seeing a client forced to liquidate while prices are low solely because they suddenly need some cash.

Might today’s volatility turn into a declining market? Perhaps. But keep in mind that a declining stock market does not necessarily translate to a completely dismal picture for you. That’s because your EMAP portfolio is highly diversified and, for many of our clients, stocks represent only a portion of your total investments.  As was demonstrated during these past couple of years, EMAP’s diversification and strategic rebalancing reduced the volatility your portfolio experienced, compared to the overall stock market, and your account’s value recovered faster than the stock market, too. Although we cannot make any promises or guarantees about the future, we would hope for similar results should another market decline occur.

Those who have been with us for more than a decade well understand this point, having lived through the tech bubble and the credit crisis.  “Here we go again,” they might say with a sigh. But panic would be absent, thanks to their experience. Clients who have been invested in EMAP only a couple of years, or perhaps just a few months — might not yet have developed the level of confidence that comes from years of actual, living results. We’re confident, though, that today’s newer clients will soon come to appreciate the advantages that EMAP offers.

Despite all this, if you conclude that, emotionally, you’re better off reducing your portfolio’s exposure to volatility, give your planner a call.

There’s a tale about the fellow who fell into a hole and couldn’t escape. He called for help, and a man arrived. He said, “I’ll go get help!” and left. Another man arrived and tossed down a rope, but it was too short to reach the fellow in the hole, so he left. A third man arrived and jumped into the hole. “Why did you do that?” the fellow cried. “Now we’re both in the hole!”

“Don’t worry,” the man said. “I’ve been here before, and I know the way out.”

And, as we look around the hole in which we find ourselves, we see the way out, and we don’t find any ghosts or goblins anywhere.

As always, feel free to contact your planner if you have any questions.

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