Coping with Market Volatility

The stock market plummeted in September amid widespread economic fear and uncertainty. There is concern that Greece may default on its sovereign debt which could trigger additional financial crises within the eurozone. In the US, policy makers have struggled with the federal deficit and the fragile economic recovery. Even perceived safe havens, such as gold and the Swiss Franc, have lost value in the past month. It is all reminiscent of 2008, when the sub-prime mortgage crisis triggered a global market meltdown. This time, however, the focus of concern has shifted from corporate to sovereign balance sheets. These problems cannot be resolved quickly, and the resulting uncertainty has led to large stock market declines causing feelings of anxiety, fear, and helplessness among investors.

These are natural emotional responses, but acting on them can end up doing us more harm than good. Here are a few thoughts to help keep our emotions in check and our investment plans on the right track: 

• Abandoning stocks at a time like this will not only lock in the recent losses, but is akin to running away from a sale. The recent market losses reflect a discounting of equity prices to reflect higher risk, which should lead to higher expected returns going forward.
• Market recoveries can occur just as quickly and violently as market downturns. One of the dangers of market timing is that missing just a few of the best days in the market can have deleterious effects on your long-term returns.
• Try to look past short-term market fluctuations, even severe market corrections like we’ve had lately. Instead, think in terms of years or even decades. If the global economy eventually recovers and prospers, as it always has, long-term stock market performance should be fine.
• Never forget the power of portfolio diversification. While equity markets have had a rocky time in 2011, fixed income markets have flourished, making the overall losses a little more bearable.
• Nothing lasts forever. Smart investors temper their enthusiasm during market booms, and try to keep a reserve of optimism during market busts. Just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the upturn when it comes.

Market volatility is disconcerting, to say the least, and the feelings being generated are completely understandable. But through discipline, diversification, and persistence, the ride can be made bearable. At some point, value will re-emerge, risk appetites will re-awaken, and for those who acknowledged their emotions without acting on them, relief will replace anxiety.

Please feel free to contact me any time with questions or comments.

Jeffrey J. Brown, MD CFA
Principal, Shearwater Capital

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