I’ve written a few articles now about the volatility in the U.S. stock market, especially as it pertains to reacting to China’s stock market (and the time before that too). A few years ago, the trouble was Greece, if you can remember that far back. Sometimes, it seems like last month is ancient history to market watchers. I’ve also written about how overreacting to bad news isn’t wise, but, what is really going on with the stock market, and what should real investors think?
America vs The World Stock Market
First, it is important to notice the difference between the American stock market reacting to news about the U.S. and the American economy, and reacting to the news and stock markets of other economies.
While world economies are more intertwined than ever, the circumstances in China are not the same as they are here. While the Chinese economy is stuck in a tricky place thanks to ongoing government intervention, and rising debt loads, the U.S. economy actually could probably use a bit of government help.
The markets don’t like uncertainty, though, and a lot of what you are seeing in the stock market today, and other days, is nothing more than that.
The last stock market plunge ended quickly when actual U.S. news about stronger employment came out. Watch for the current market situation to react decisively (in either direction) to U.S. based news as well.
America vs Optimists and Pessimists
Analysts and financial journalists spend a lot of time talking about whether or not the stock market is overvalued or undervalued. This is a fancy way of trying to say whether or not the stock market is priced “correctly.”
The idea is that sometimes investors get too optimistic or too pessimistic and the price of stocks gets out of line from where they “should” be. The trick is that there are a lot of competing ways to determine what a stock’s price should be. That being said, the almost universal consensus among analysts is that the stock market is either overvalued, or valued correctly. You’ll have to look pretty hard to find someone who says the stock market is undervalued.
What this means is that the markets will look for any excuse to move back from current prices. A Chinese stock market plunge, lower oil prices, or a North Korean missile test are all as good of an excuse as any other.
Before you get the idea that this means it is time to get out of the stock market, remember that no one actually knows when stock prices are correctly priced, or when the transition from overvalued to undervalued happens. If you are sitting out the wrong week, or even just the wrong day, it can cost your returns plenty. For long-term investors, it’s better to wait for the rapid rise and fall of each day’s market prices to smooth out into the more gentle long term trend.
The period of volatility with lots daily up and down without much impact on the overall long-term direction of the market is known as consolidation. This is a good thing. Without it, stock prices get to high, too fast. Unfortunately, no one ever seems to remember to call it consolidation until it’s in the past and you can clearly see it in a stock chart.
Machine vs Machine
One of the most important things to remember about the modern stock market is that something like 90 percent of all trades are machine trades. That means that the current volatility is just as likely caused by one computer program amplifying another computer program, which causes that program to respond, which causes another program to respond, and so on. Chances are that your average American didn’t wake up this morning and dump his long-term holding in GE just because the Chinese stock market fell overnight.
Never forget the purpose of your investments. If you own Apple stock because you believe in the long-term strategy and management of the company, then that has nothing to do with how China’s stock market is doing. Likewise, if you own an S&P 500 ETF because you believe that over the long-term, the U.S. market average a 10% annual return, then that has nothing to do with China’s stock market either.
Doing Nothing vs Not Overreacting
There is a very real difference between doing nothing and not overreacting. If you are invested in American oil exploration stocks, you need to take a serious look at the fundamentals and future of that industry. Things, real things, have changed a lot in that industry over the last year.
Likewise, if any of your investments have their success tied closely to the Chinese consumer, I’d be monitoring that carefully as well. If either the Chinese market or debt burden cause an economic pop, you could see hugely reduced consumer demand there.
Doing nothing in cases like this is not wise. You need to monitor and assess your investments. But, be sure you are reacting to the actual world around your stock investments and not to the stock movements themselves which are faster, more volatile, and more arbitrary than actual things that affect corporations.
Finally, if your investment strategy is a diversified portfolio and a long-term horizon, remember that the point of the strategy is to be invested in everything so that your ups cancel out your downs and smooth the overall volatility. If you no longer believe in diversification, that is one thing. If you think that you can still be diversified while removing various asset classes from your portfolio (like by selling all your stocks today), that’s a completely different thing.
In the end, remember to look for real, U.S.-based, economic news and statistical TRENDS, and ignore the ever changing daily excuse about why the market is up, down, or sideways today.