Paul Anthony Samuelson, an American economist and the first American to win the Nobel Prize in Economics, famously wrote in a 1966 Newsweek article: “Wall Street indexes predicted nine out of the last five recessions!” The quip has since been widely quoted in economics literature to remind us that the best economists, and even the markets themselves, do a poor job of predicting the future. As global stocks experience renewed volatility, there have once again been cries from doomsayers that the next recession is around the corner, creating a sense of fear among many investors. It is understandable that investors become nervous when the markets are volatile, but as Samuelson reminds us, not every market drop is the beginning of a renewed recession.
What is certain is that we are entering a period of higher volatility than we have seen in the past. What I mean by higher volatility is that the stock market is likely to have higher swings both up and down during 2016. Markets don’t like uncertainty and there are a number of significant factors that could help or hurt the economy in 2016. In this article, we will delve into a few key factors that are driving recent market volatility and what, if anything, investors should do about it.
Federal Reserve
Over the past 4 years, markets have been very stable due to a very clear policy stance by the Federal Reserve: the Fed committed to keeping rates low for an ‘extended period of time’. Now, however, the path forward is less clear as the Fed begins to raise rates. Will the Federal Reserve move too quickly, too slowly or will they navigate the economy perfectly as they raise rates?
Oil
Historically, lower oil prices have been positive for the global economy as consumers spend less at the gas pump and have more available for spending elsewhere. Over the past 6 months, however, stocks have been rising and falling in tandem with oil, as investors look to oil as a bellwether of global growth and the financial health of oil-producing nations. The drop in oil, therefore, has been seen as a negative indicator of global growth and financial health. Will oil prices stabilize? At what price?
China
China’s economy, the second largest in the world is slowing. As we have written before, China has a highly managed economy, and highly managed economies will often have significant imbalances. China’s current imbalances appear to be in the form of high debt levels and overinvestment in certain areas of the economy. Will China be able to stabilize their economy? How long will it take?
What to do about it?
While it is tempting to jump in and out of the market during periods of high volatility, we believe that this is a time to stay disciplined. Periods of high volatility can actually be good for a disciplined investor. A disciplined investor resists the temptation to buy or sell solely on recent market movements and instead has a well thought out strategy that goes beyond recent events. We believe that discipline starts with knowing your goals and creating a diversified strategy that is crafted to best achieve your goals. Secondly, we believe that a key part of discipline is knowing your risk level so that you can avoid making decisions based on fear if the market falls. Lastly, we believe that disciplined investors take advantage of volatility by rebalancing into those assets that have become more attractive.
Paul Samuelson reminds us that the future is unknowable. During periods of uncertainty, it is even more important to focus on these investing disciplines. While we can’t know the future, we believe that these fundamental steps provide the best approach for our clients to ultimately achieve their goals.
"Wall Street indexes predicted nine out of the last five recessions." Newsweek, 19 Sept. 1966.