Keeping Volatility in Perspective

Many people are, without a doubt, concerned over what has been transpiring in the markets over the past few weeks. I wanted to address some of the concerns you may have been feeling.

For me, some of the most interesting times to be a long-term investor are those periods when short-term investors are looking over their shoulders for an excuse to sell. They’re convinced that the market is going to go down before they can get out, and so they jump on any piece of bad news that comes across their screen.

And, of course, Friday and now today was a perfect time to see this in action. With all the economic drama playing out in the world, there were plenty of opportunities to panic. The Greek Prime Minister has resigned! Sell! China devalued its currency by 2%! Head for the hills! Chinese stocks are tanking yet again! Get out of American stocks while you can! The Fed might raise short-term interest rates from zero to very nearly zero! It’s the end of the world!

A sober analyst might wonder whether a change in governance in a country whose GDP is a little less than half the market capitalization of Apple Computer Corp. is really going to move the needle on the value of U.S. stocks. Chinese speculators are surely feeling pain as the Shanghai Composite Index goes into free-fall, but most U.S. investors are prohibited from investing in this tanking market. And does a decline in the Shanghai Composite mean that American blue chips are somehow less valuable?

If we take a take a broader, more rational picture of our current economic situation we see the S&P 500 as of the close of market today was trading at 15.2 times forward earning, below its 25 year average.

Additional news says it hasn’t been this cheap to fill your gas tank in over a decade, which is as good as a pay raise for most individuals. Businesses that rely on energy to manufacture their goods are now forced to figure out what to do with the excess capital they’re not spending on fuel. Don’t forget that American corporations have enormous piles of cash for which they have no use and may have no choice but to return some of that money back to shareholders in the form of record dividends.

And unemployment is so low that wages for American workers are going up, and that could raise consumption and demand for products and services. Meanwhile, contributions to 401(k) and other retirement plans are up dramatically, housing starts and the construction sector are booming, and the Federal Reserve might decide that it no longer has to keep short-term interest rates low because the emergency is over and the economy has recovered. Which means many retirees might actually get a decent rate of return on their cash and CDs. (I apologize—tongue in cheek—for bringing you all this terrible news.)

However, referencing all of the above, you shouldn’t be surprised if the U.S. stock market suffered a 10% or even a 20% decline because, as I frequently mention, market declines are a normal stock market behavior, just like temper tantrums are a normal behavior from toddlers.

So what can you do with that information?

If the market continues to capitulate, this swing may provide an opportunity to buy into a cheaper market. If you are an accumulator (someone saving for your goals), maybe it is time to increase your monthly retirement or college education savings contributions.

And, for those of you in retirement or who have short term needs from your portfolio, the funds for these goals is sitting in cash or cash equivalents. So the money that is sloshing around is money you won’t need for three or more years down the road.