“For those properly prepared in advance, a bear market in stocks is not a calamity but an opportunity.” ~ Sir John Templeton
Question: Why were financial markets so volatile during August? Was it all because of China?
Answer: China’s currency devaluation and overall economic slowdown were the likely catalysts for the recent dramatic declines, yet other factors also fueled the fluctuations. It’s convenient and tidy to pinpoint one reason for the market’s downward drift, but it’s usually not that simple.
Slow(er) Boat to China
For the past twenty years, China has experienced frenzied growth. The pace of this increase has actually been slowing for some time now, resulting in the slowdown. Since last June, China’s primary stock exchange fell sharply, down roughly 40 percent. In an attempt to stimulate their economy, on August 11, 2015, China’s central bank devalued their currency. The thought process was that diluted currency would make exports less expensive and more attractive to consumers. The immediate reaction, however, was worry and fear, causing markets to drop and contagion to prevail.
The last time we experienced a “Tower of Terror” market ride with a plunge of 10% or more was four years ago in October 2011. This extended time lapse allowed our “built-in forgetters” to kick in, causing many of us to forget that investing does involve risk and volatility. Scholars refer to this phenomenon as “recency bias,” a term meaning that we’re hard-wired to focus primarily on recent trends and patterns, believing that present events will continue indefinitely, remembering only what is freshest in our minds.
Bloomberg reminds us that since World War II, market corrections take place approximately every twenty months, with the average correction lasting 71 days, resulting in a 13.3% decline. The definition of a correction is a 10% to 20% drop in a major market index. This time the S&P 500 Index fell more than 10% in just four days, so yes it was breathtaking. According to the St. Louis Fed, at one point during August, markets were down 12.35%, which fits the bill for a correction.
In the midst of the turmoil, it is important to recall what you own and why you own it. Three disciplines designed to help us with this and provide understanding as to what’s behind market forces and perceived valuations are: 1) Fundamental analysis which evaluates economic facts and events; 2) Technical analysis which is more statistical in nature, relying on historical pricing, patterns and charts; and 3) Behavioral analysis, which focuses on how human behavior and emotions influence markets. In this recent dip, all three categories came into play with a heavy emphasis on behavioral analysis, or in this recent instance, fear.
Many factors contribute to Wall Street’s worries, including slowing global growth, lower oil and other commodity prices, interest rate uncertainty, budget deficits, terrorism, and employment figures. Markets abhor uncertainty, and we have plenty of that right now. Overemphasis on recent events, whether positive or negative, along with discounting long-term reality can cloud judgment, leading to overreaction.
Selling Causes Selling
“Margin call, gentlemen…” is a line from one of my favorite movies, “Trading Places” (1983) with Dan Aykroyd, Eddie Murphy and Jamie Lee Curtis. Traditionally thought of as a Christmas movie, this classic provides wonderful insight into market mechanics, specifically the potential risks of using margin, which entails borrowing money to make investments. Since individual investors rarely use this technique, we won’t go into much detail. Suffice it to say that it may increase risk while magnifying results, whether they’re positive or negative.
Selling is often contagious. When markets drop, and selling pressure snowballs, margin users may need to repay loans even if the collateral for the original loan has decreased in value. Check out “Trading Places” for a glimpse into the lives of Wall Street tycoons, Mortimer and Randolph Duke as their world comes undone with the utterance of those three words “Margin call, gentlemen…”
It’s no coincidence that September is National Preparedness Month. Preparing for uncertainty, whether it’s financial or weather related, promotes peace of mind. Having a plan for circumstances you can’t control is prudent. The sun will come out tomorrow, or the next day, but what will you do in the meantime so you won’t be caught off guard physically or fiscally? Ready.gov has an emergency preparedness publication available at no cost that is a great resource, especially this time of year.
Markets and weather are cyclical in nature. An investment policy statement will provide structure and a long-term perspective to your financial life during turbulent times. Although disconcerting, declines are normal, natural and necessary. Seeing the short-term impact of volatility on your portfolio is unsettling. If your cash-flow needs, timeline or risk tolerance has changed, consider consulting with your advisor to discuss your goals and reimaging your plan. Stay focused and invest accordingly.
The S&P 500 Poor’s 500 Composite Index is an unmanaged market capitalization-weighted index based on the results of 500 widely held stocks. The index has no expenses; investors cannot invest directly in an index. Past results are not predictive of future results. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed.
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This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email email@example.com Website: www.raymondjames.com/Darcie