Fasten Your Seatbelt, Volatility Ahead.
Posted on September 14, 2011
Filed Under Mutual Funds, Personal Investing, The Economic SceneMuch as I hate to embrace clichés, when it comes to stock market volatility it does appear that we better get used to “a new normal.” As a recent New York Times article showed, it’s not your imagination—the stock market is more jumpy than ever. Moves of three or four percent, up or down, used to be uncommon. No longer. According to the Times investigation, since 2000, “price fluctuations of 4 percent or more during intraday sessions have occurred nearly six times more than they did on average in the four decades leading up to 2000.” (A move of 4% when the Dow is at 12,000 equates to 480 points.)
What causes these nerve-rattling moves? Pundits differ in their explanations, but I believe a primary factor is the new widespread reliance on computers to make trades. These unthinking machines are basically trend-followers, placing huge bets in nano-seconds. They buy and sell based on stock price movements. They are unconcerned with the traditional drivers of stock markets: price-to-book ratios, new products in the pipeline, quality of corporate leadership, etc.
As a result of these trend-following robots, each trend becomes magnified, for better or worse.
Another factor is the significant increase in the use of Exchange Traded Funds. ETFs, unlike traditional mutual funds, can be traded throughout the day. While this feature is touted as a benefit, we think otherwise. Investors seem willing and able to jump in and out more quickly, often to their financial detriment. Mutual funds, on the other hand, can only be traded at the end of each business day, and in my opinion that helped, in the past, mitigate market fluctuations.
Whatever the cause, the message is clear – you cannot allow the frequent and wild price swings to deter you from sticking to your long-term investment plans. Over a period of months, the markets will filter out the short-term noise and revert to economic fundamentals.
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