Market Volatility: The Real Lesson

I don’t get a lot of panicked calls and e-mails when the market melts up, like it did yesterday. When the market rises 2 percent, the sense seems to be that it’s just the universe working out the way it should. But when the market drops 2 percent? Something must be out of whack! And yet, both are signaling the same thing: the markets are struggling to put a price on future uncertainty. When markets bounce around that much, it is because there is real disagreement about what the future could hold and what that means for corporate profits and, therefore, for stock prices.

So, when I note a substantial jump, I see a market that is just as confused as it was last week, when prices dropped. Sure, I like the up move much more than the down one. But since I know what the move means, I can’t and don’t take it for an “all-clear” signal. Instead, I see it as a sign that volatility is likely to continue.

A confused market

Think about it. The market is confused enough to bounce prices around. This means that in the absence of a generally agreed-upon solution, prices will continue to bounce around, swayed by every piece of news and change in sentiment. In fact, this movement is what I expect to see over the next couple of months.

This fluctuation is not necessarily a problem. In many ways, it is a return to normal. By and large, investors have been unusually complacent, and markets unusually calm, over the past several years. Why? Central banks were determined to calm economic fluctuations, and market fluctuations subsided. Now, central banks—with the Fed in the lead—are starting to pull back and leave the economy to its own devices. As such, economic volatility is coming back and, therefore, so is market volatility.

The new normal

As I wrote yesterday, I believe that the market is headed higher over the next several months. I also believe, however, that even as the economy continues to grow and as it becomes more normal, we will see more volatility. A choppier ride, even if it is up, is likely to be much more uncomfortable than what we have seen recently. As investors, we need to adapt to the new normal and be prepared for it.

Given rising volatility, it becomes even more important to keep an eye on the real risk factors that can signal trouble ahead, which we do at Commonwealth and on this blog. It is also even more important to understand our own risk exposure and ability to weather that volatility, which you have to do yourself with the help of your advisor.

The real lesson

The real lesson of last week and of yesterday is that volatility—either way—could derail your financial goals if you let it. My job, and that of your advisor, is to help keep your investments on track no matter what happens, good or bad.

Don’t get too excited. Don’t get too upset. Do get to your own finish line by just staying the course. Through all the ups and downs, that is what we are here for.