Fear of the Stock Market

http://www.nytimes.com/2012/05/29/business/retreat-from-stock-market-continues.html?hp

The link is to an article in the New York Times dated 5/28/2012, “After Facebook, More Fear of Stock Market”.   In referencing a previous article regarding decreasing volume and investor participation since 2008, the article suggests that investors are losing confidence in the stock market, and the growth they previously thought it would afford.

There are many reasons we might suggest to understand the situation, not the least of which is the current economy.  In our post “The Magic of 1980 – 2000”, factors were laid out that were part of the market’s dynamic.  The flow of investment dollars from the 401(k) explosion, the junk bond phenomenon, the tax law changes, advancing computerization, derivatives, all and more created a great deal of stock market growth.  The bond markets also appreciated the various factors and encouragement to grow in size of issuance, trading, and resulting investment.

There is an assumption of inevitable strong growth on the part of many investors.  How many times have we heard the “sophisticated” retail (i.e. small) investor say “yeah, it’s lower, you have to buy it (the market), it’s going up”.  In the professional markets, it’s all too frequent that the phrase “it’s too cheap” is heard.  (Those in the know realize that things change; when something gets cheap, it’s often a good idea to find out why).  What seems like inevitable and near-term strong growth, accepted on massive assumptions, could lead to frustration.

The problem is that in either the retail or professional investor ranks, there are many, many players who believe in the inevitability of the upward move.  We do too.  BUT, it’s a question of timing, consistency and velocity that separates the herd.  The question we asked in a previous post was what should you expect?  If we accept that we’ve just had a very volatile decade of investment returns, that we’ve had a high rate of stock market growth in the roughly 20 years preceding the last decade, that we had clearly lower rates of growth before that, what is reasonable to expect?  If we could suddenly remove volatility, what should we expect of the stock market?

Maybe it’s time to think about how to get away from stock market volatility.  The Facebook IPO certainly exposed some negative attributes of the investment markets.  The idea that some investors get information that others might not, not new but certainly uncomfortable.  The performance of the Lead Underwriter (Morgan Stanley) and the performance of the stock, again not comfortable.  The fact that the exchange (NASDAQ) experienced some glitches was bad, just bad.

There is risk in investing.  To assume otherwise is both naive and wishful thinking.  The stock market has been particularly volatile for years now, and it should strike the investor that portfolio structuring should involve some level of volatility immunity.

If we accept Modern Portfolio Theory (see previous post) as a basis, we know we need to deal with non-correlated assets.  Simply put, that means that if some part of our portfolio goes down, some other part doesn’t, or even goes up.  If the parts were correlated, they’d both move in the same direction as effected by whatever factor is the cause.

In the normal portfolio structuring, stocks would be offset by bonds.  The textbook says interest rates down, bonds go up.  If bonds go up, stocks go down.  The reality is that both moves are sometimes based on economic expectations and both may move in concert.

What to do?  Tune in next week….

 

About L N Himel

Site creator and author has well over 30 years experience in the world of Finance at both the institutional and personal levels. As is often true, his successes, but also the pain of the author's mistakes, have resulted in insights that you, the reader, might find helpful in your efforts to avoid pitfalls and poor results. Associated with Himel Financial Services, at http://www.himelfinancial.com/#intro
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