At times like this, old-fashioned advice such as ‘buy, hold, and don’t pay attention’ works extremely well. I’ve had several clients call over the past few weeks concerned about the day-to-day volatility in the stock and bond markets. I try to quickly remind everyone that asset allocation, diversification, and a solid financial plan are the ways to help achieve wealth--not cashing out a stock when it’s making money and trying to time getting back in after the price drops. That strategy, known as market timing, is a losing proposition over the long run and is better to avoid altogether. So what has the market in such a panic? I’ll give you a few different perspectives.
First, you have those technical guys who think market conditions such as tight credit and high oil prices have nothing to do with anything. They believe the market moves from a technical standpoint only and analyzing the state of the economy is a waste of time. Technical traders believe markets can be read--even predicted--based on chart patterns. Having a technical perspective probably makes sense to many when it seems like even when good news pervades the markets, stock prices find a way to decline by 4:00. Many people who analyze the market in this way expect to see a 10% ‘correction’ (dip) in stock prices at least once every five years. As of this week, we’ve seen the 10% correction and the markets bounced back strongly between Tuesday and Wednesday.
At a more logical level, we have the ‘fundamentalists’ who believe that incoming economic data is the greatest driver of stock and bond prices. For example, if home sales are doing poorly, consumers will likely spend less money in the future, resulting in lower sales for corporations and ultimately lower stock prices. This is certainly easier to digest than technical theory, even if the markets seems to ‘do their own thing’ every so often. In the current market, fundamental traders and advisors will blame lower stock prices on the weak U.S. dollar (relative to the Euro and Yen), high oil prices, slowing home sales and a tightened environment for borrowing.
At a personal level, I agree with much of the current fundamentalist sentiment--except for the weak U.S. dollar. My understanding is that a weak dollar will ultimately balance itself out in the stock market. If our goods are cheaper to purchase with Euros and Yen, then Europe and Asia will buy a lot more goods. We’ve already seen this in the real estate market, as more international buyers have been flocking to the U.S. than ever before.
We also saw a major investment this week in a U.S. financial company from Abu Dhabi. In this case, the purchase was in the form of petrodollars rather than Euros or Yen, but still exemplifies using foreign cash to buy into dollar-denominated goods. If you studied the business models of each company in the S&P 500, you’d learn that most of them do substantial business overseas. The currency discrepancy simply improves one aspect of their business (overseas sales) and weakens others (U.S. sales). Over time, it balances out.
So we return to the old adage ‘buy and hold.’ If anything, lower stock and bond prices present an opportunity to purchase more securities at lower prices. Once oil prices return to historical levels, the dollar gains some traction, and people stop buying homes which they can’t afford, the attention will shift back to corporate profits, where things seem to be business as usual. And as for a recession... no I don't think its on the horizon. Quite the contrary.