2016 started with a stock sell off and full-blown correction (down 10 percent from the recent peak), challenging investors to remain calm and stick to their game plans. Then Brexit came along and once again, rattled nerves. Today the Cassandra's are out again with an old worry: the Fed will kill the stock market rally. The reignited jitters have been attributed to a few central bank officials hinting that the improving economy may justify an interest rate increase as soon as next week’s Fed meeting. Previously, there seemed to be little doubt that the central bank would wait at least until the December meeting. While most believe that December is still more likely, the selling acknowledges that the most recent leg up in stock prices occurred NOT because the economy is humming and companies are making a lot of money; rather the buying has been a sign that big investors feel with interest rates so low, stocks are the only assets that can deliver any potential for gains. As Federal Reserve Governor Daniel Tarullo recently acknowledged “There's no question...when rates are low for a long time that there are opportunities for frothiness and perhaps over-leverage in particular asset markets.” (Emphasis added!)
In other words, when rates stay so low for so long, investors look past fundamentals, drive prices higher and can become complacent. One sign of that complacency can be seen in the VIX index, which is a measure of the expected swings in the S&P 500 over the next thirty days. Recently, the 30 day annualized volatility (of daily changes) in the S&P 500 fell to its lowest level since 1994. Friday’s selling may simply be proof that people periodically remember that the risks they previously accepted, may no longer feel so great, especially considering the age of the bull market. But as the analysts at Capital Economics note, “The fact that volatility was low in the mid-1990s did not preclude equity prices from rising for several years as a bubble inflated.”
Still, when you hear dire predictions, it’s hard not to feel butterflies. Although some investors may be tempted to sell, they do so at their own peril. Market timing requires you to make two precise decisions: when to sell and then when to buy back in, something that is nearly impossible. After all, even if you sell and manage to steer clear of the bear by staying in cash, you will not be able to reinvest dividends and fixed-income payments at the bottom and you are likely to miss the eventual market recovery. The best way to avoid falling into the trap of letting your emotions dictate your investment decisions is to remember that you are a long-term investor and you do not have all of your eggs in one basket. Try to adhere to a diversified portfolio strategy, based on your goals, risk tolerance and time horizon and do not be reactive to short-term market conditions, because over the long term, this strategy works. It’s not easy to do, but sometimes the best action is NO ACTION.
If you are really freaked out about the movement in your portfolio, perhaps you came into this period with too much risk. If that’s the case, you may need to trim readjust your allocation. If you do make changes, be careful NOT to jump back into those riskier holdings after markets stabilize.