Clarksville, TN – The intense volatility that has recently gripped U.S. and global stock markets was much in evidence this week. Stocks staged a broad retreat Wednesday after rallying strongly Tuesday when the Federal Reserve Board pledged to keep interest rates near zero through 2013.
Tuesday’s advance followed a dramatic selloff on Monday, the first day of trading on U.S. exchanges after Standard & Poors announced it was stripping the U.S. of its AAA credit rating.
The sharp swings in stock prices – the Dow Jones Industrial Average dropped 5.5% on Monday, rose 4% on Tuesday, and fell more than 4% Wednesday – demonstrate the uncertainties plaguing investors. The Fed said it was prepared to employ its policy tools “as appropriate” – a reference some investors took to mean additional monetary stimulus in the form of QE3 might be on the table. However, the central bank also acknowledged that U.S. economic “growth so far this year has been considerably slower” than it had expected, a reminder of the difficulties besetting the economy.
While economic uncertainty and market volatility seem likely to remain with us for the foreseeable future, it’s also important to remember some key facts:
- Although the S&P downgrade was of course unwelcome, investors worldwide still regard U.S. government debt obligations as safe and highly attractive. For example, the Treasury sold $24 billion worth of 10-year notes Wednesday at an extremely low yield of 2.14%. If investors were truly worried about a U.S. default, they would be demanding much higher yields. While much criticized, the recent agreement in Washington raising the debt ceiling ended the immediate question of default.
- Corporate earnings are robust, with some 61% of S&P 500 companies reporting so far beating their second-quarter earnings estimates, and 68% exceeding their revenue estimates. Corporate profit margins and balance sheets are also very strong.
- While U.S. economic growth has slowed, as yet there is no solid evidence that the country is sliding into recession. This view is reinforced by the fact that long-term interest rates remain well above short-term rates. Every U.S. recession in the past 50 years has been preceded by an inverted yield curve (short-term interest rates above long-term interest rates).
- Markets often overreact in times of uncertainty, and investment decisions made in haste during periods of anxiety are often regretted later on.
It’s normal to be concerned during periods of extreme market volatility. However, while investors must always be alert to changes in the economic and investment climate, market fluctuations are not a valid reason for abandoning your long-term financial plan. This is a time for calm and close communication with your financial advisor, and a time to remember that while stocks may fluctuate sharply in the short term, they have generally rewarded patient investors over the long term.
The ongoing volatility in the markets is obviously something I am watching very closely. In times like this, we must strike a balance between vigilance, which is certainly warranted, and emotional response, which is not. If you would like to discuss the current investment environment or have any concerns about your individual holdings, please give me a call.
