Stocks seemed to peak back on July 19th as subsequent weeks brought increased volatility and lower prices. We know this not to be true as early October brought even higher highs.
This week we seem headed lower once again. We see increased volatility – common during earnings season – due to uncertainty over next week’s Fed meeting, concern over bank earnings, oil prices above $90, fear of credit contagion or whatever the excuse du jour might be.
It’s a good thing we were paying attention (were we?) to the ups and downs of the July – Oct timeframe. There were many lessons to have learned.
LESSON 1: SLOW AND STEADY WINS THE RACE
It’s a modern day tortoise and hare story. Traders jumped in and out of positions many times during the volatility. No doubt some of them made a lot of money. No doubt some lost a lot too – several prominent hedge funds among them. But what about the buy and hold investor? Choosing to sit tight and ride out the ‘crisis’ erased any paper losses while avoiding trading costs and taxable transactions.
LESSON 2: FEAR IS FOR THE FOOLISH
Ayn Rand’s John Galt had a “face without pain or fear or guilt.” Investors who chose not to sell into the panic were equally at peace. August 19th marked the low point. Trading volume was massive. The foul stench of panic selling was in the air. Of course no one will admit to doing so but it was out there. There’s a seller and a buyer to every transaction.
Sure, some selling was due to margin call requirements. OK, fine. Anyone else who sold needs to reassess investment strategies. Volatility and panic make for wonderful entry points – not times to bail out.
Decisions rooted in fear go a long way in explaining why the typical investor buys high and sells low.
LESSON 3: RISK PROVES NOT ALL FOUR-LETTER WORDS ARE BAD
Put down the bar of soap Mom. You heard us.
No one enjoys losing money yet risk is omnipresent. Embrace it. Love it. Win with it.
On one extreme, risky investors make a lot and lose a lot. They forgo acceptable risks and assume unacceptable ones. They may avoid their destiny in the short-run but almost always get crushed in the long-run.
On the other end of the spectrum, risk averse investors never lose and never win.
Smart investors – those who make choices based upon smart risks – make money in up markets and fare better in down markets. They are rewarded for assuming acceptable risks and avoiding unacceptable risks. Viva volatility!
The last few months remind us that investing and risk go hand in hand. It’s our risk choices that largely determine our success.
LESSON 4: THE FED IS DISINTERESTED IN THE FORTUNES OF INVESTORS
We said it in our note to clients when Big Ben cut the target Fed Funds rate by an unexpectedly large 50 bps (0.50%). We reiterate this point today. The Fed simply doesn’t care about investors.
What The Fed does care about is meeting their dual mandate – promoting both economic growth and price stability. To this end, they must concern themselves with properly functioning credit markets. This explains the August rate cut.
Future rate cuts (assuming they come as expected) will be aimed at maintaining economic growth within a stable price environment. That any particular type of investor benefits or loses as a result of Fed action (or inaction if that’s what proves to be) is purely ancillary.
Did we learn our lessons? Our actions during this current period of volatility will go a long way in answering this question.