Saturday, September 18th, 2021

Why The market volatility?

Posted: Monday, September 26, 2011

By Elaine Bedel, president, Bedel Financial Consulting

The stock market ended up for the day Friday, but still down significantly for the week. Why are we having such market swings? Are we really investors or merely gambling with our money? Here are our thoughts on the current market influencers. During the week, we experienced large negative swings in the stock market after an announcement of a significant new program from the Federal Reserve. What does the announcement mean? What other issues create concerns? And what should investors do?

Refinancing the Federal Debt

Last Wednesday, the Federal Reserve announced a new program that they feel will help stimulate our economy. This program, dubbed “Operation Twist” allows the Federal Reserve to sell short-term U.S. Treasuries and use the proceeds to buy long-term U.S. Treasuries. The impact on the bond market should be lower interest rates for long-term bonds and a negligible impact on short-term rates. Whether long-term rates move materially lower or stay low for an extended period of time remains to be seen.

We like the program because it doesn’t cost anything. New money is not being printed, which could further devalue the U.S. dollar. The Fed is using money already in circulation to buy the bonds. In essence, it can be viewed as a “refinance opportunity” for our government debt. A majority of U.S. government debt is short-term. Locking in low interest rates for longer periods of time can be beneficial. We feel that the potential positive effects outweigh the potential negative effects. Of course, unintended consequences are always a threat to any strategy.

The bond markets reacted somewhat expectantly with long-term rates moving lower and two-year rates rising. The stock markets reacted negatively; perhaps due to an acknowledgement by the Fed that significant problems exist that could cause our economy to perform worse than anticipated. It was probably the word “significant” that caught the market’s attention. Still, these problems are not new news.

Market Volatility Due to Other Concerns

There are significant problems and we feel that in the short-run, stock markets will continue to react to the following issues:

• Europe’s Financial Issues. We are concerned with Europe’s ability to gain control over its debt issues. Thus far, their efforts have been below expectations. Early Friday morning, European countries announced they are committed to a coordinated effort that will ease their financial crisis. Among many issues to be resolved, there is the potential default on Greek bonds and Ireland’s looming financial problems. Thus far, Europe had hoped that words and time would make their problems disappear. However, until real action occurs, markets will likely remain skeptical. It is important to note that Europe’s financial authorities not only have to agree on changes, but then each member country must convince their government to agree. While time is of the essence, the process to reach agreement from the independent governments of the European Union cannot be easily expedited.

• Economic Slowdown of Emerging Markets. There is an intentional slowdown occurring in emerging market economies. Our concern is whether these economies slow down too much. Countries, including Brazil and China, are tightening their economic policies by raising interest rates and making money tougher to borrow. This is intended to cool off their economy and the strategy appears to be working. However, the emerging market countries are a growth cog in our global economic machine. When demand for products and services from these countries is decreased, the impact is certainly felt in the U.S.

• Clear and Effective U.S. Fiscal Policy. We are concerned with the inability of our government to agree on decisive policies that will be fiscally responsible in the long run, yet not harm the economy in the short run. We have all heard the rhetoric from Washington regarding our country’s issues and potential solutions. Unfortunately, no decisions have been made by our elected officials. With uncertainty regarding future economic and tax policies, U.S. industries are forced to take the sidelines. Until we have clarity regarding policies, our stock market and its investors will continue to be cautious.

While each of these concerns is significant and represents headwinds for the global economy, the concerns are well-known and our stock market has reacted accordingly. Will these issues continue to impact the stock market? The answer is “yes” given what efforts have been made to-date to eliminate the concerns and reduce fears. However, we could be positively surprised. Europe could take well-coordinated action. Emerging markets could see more tame inflation and moderate growth. And, our government could make progress toward passing policies that tackle long-term debt problems and still spur economic growth. If this happens, stocks will likely do very well.

What’s Next

We try to avoid short-term guessing when it comes to stocks. However, we do like one factor that bodes well for stock investors, and that is valuation. If you read news articles today, you are likely to find references to valuations not being this low since March 2009. Most references will cite Price to Earnings (P/E) ratios as evidence. While P/E ratios are not leading indicators, they are an indicator of value. Stock markets that trade at lower valuations have a stronger likelihood of outperforming than stock markets that trade at higher valuations. Low valuations, combined with higher dividends and corporate earnings growth, which we expect to continue, represent good long-term investing opportunities.

So while the headlines dominating our news continue to create volatility, stock investors need to pause, look at the fundamentals and realize that stocks, which are long-term investments, are becoming more attractive. While the short-term volatility is likely to continue, the long-term probability of good performance is likely to increase.