It has been a wild week on Wall Street. The markets have been on a rollercoaster ride and unfortunately, the general direction has been down. Of course, whenever we have volatility on Wall Street the talking heads come out of the woodwork talking doom and gloom. As far as I’m concerned, the doom and gloom talk is unjustified and it is times like this that require discipline from investors.
When investors see the market as volatile as it has been this week, fear begins to take over. As I’ve mentioned many times in the past, just like greed, fear is the emotion that can cause an investor to act irrationally. When investors act irrationally, they almost always make the wrong decision. Therefore, when markets are experiencing major volatility, sometimes the best course of action for an investor is to do nothing.
In looking at the market’s recent volatility, the first question is what caused it. Because markets have experienced substantial losses, many investors believe that something bad must have happened in the economy to cause the market to experience such losses. However, that is not always the case. In fact, you can argue that the recent volatility in the market is not caused by bad news; it is actually caused by good news.
When the January employment report was released it showed good news for American workers. After years of stagnation, wages were finally moving in the right direction. According to the January report, wages grew at the fastest pace since 2009. When wages rise, it shows that the job market is continuing to improve and that the current job market can be classified as a tight job market. In addition, when wages rise as they did, it’s a signal that we are in a healthy economy. However, sometimes Main Street and Wall Street see things differently. From Wall Street’s standpoint, rising wages renew fears of higher inflation, higher interest rates and lower corporate earnings. Corporate earnings have been at record level in part because of cheap labor cost. This is a perfect example of where good news is bad news.
How long will this market volatility last? I don’t know and neither does anyone else. We have seen market volatility in the past where over a short period of time markets regain their strength and hit record highs. It was only about a year and-a-half ago that markets tumbled nearly 10 percent when the British decided to depart from the European Union. That volatility lasted a short period of time and it was just a little over a month later that markets reached a new high. Investors that bailed out missed the significant turnaround.
I’ve always believed that investors should invest based upon their individual situation, not what’s happening in the market. Investors who take a long-term approach realize that market volatility is normal and it is nothing to fear. Since 1945 we had 77 declines in the market between five and 10 percent. The average length of these declines has been one month. In other words, markets retreated for a month until they recovered. There have been 27 declines between 10 and 20 percent during that same time period and the average length of decline and recovery is only four months. The bottom line: as fast as markets retreat, they can regain their strength. The bottom line investors who panicked are the ones that generally lose.
My advice to the great majority of investors is to ride this decline out. It’s not like there are fundamental things wrong with our economy, because there are not. In fact, as I mentioned earlier the main reason for this retreat is that the U.S. economy is strengthening. Let’s also not forget that markets frequently are irrational and I think this is one of those times.
Rick is a fee-only financial advisor. His website is www.bloomassetmanagement.com. If you would like Rick to respond to your questions, please email Rick at firstname.lastname@example.org.