What is happening in the world stock markets? Experts have come up with specific reasons for the wild swings, such as the downgrading of America’s credit rating, sustained high unemployment, and declining consumer confidence. I’ll look more generically and then suggest a Registered Retirement Savings Plan (RRSP), 401K, or equivalent investor approach to weathering this storm.
The real problem is fear and uncertainty. Market players hate uncertainty. During volatile periods, investors will look everywhere for hope, constantly. And when they see a flash, investors rush in and take off; Only to leave after hope fades!
Also, investors are like sheep. When the market goes up steadily, investors follow other investors and buy stocks and bonds, just because others are buying. This herd mentality leads to market bubbles like the dot-com debacle. Then people realized late that they had grossly overvalued stocks like Nortel and Yahoo!. When these bubbles burst, a massacre begins. Panic and irrational sales on a large scale begin, creating a value investor’s dream.
Generically, what is happening today? Uncertainty prevails in all major economies. European economies are in trouble. The major surgery needed in Greece will stall them for years as they grapple with the results of the government’s previous strong involvement in the economy. In addition to Greece, the EU rescued Portugal and Ireland. Now market players are worrying about France, one of the first rescuers. And let’s not forget that in the UK, the coalition government has a huge task to fix that troubled economy.
And then there is the United States. Spending beyond its means, divided legislature, in the middle of electoral campaigns. This is a perfect uncertainty formula. So, fasten your seat belts and prepare for a bumpy ride for the next two years.
What can people do in this investment environment? Be wise; reject the herd mentality. Specifically, here are some steps that can help:
- Don’t invest if you have consumer debt or a mortgage. Pay these first and then start a capital fund.
- Avoid day trading; Not only is it stupid, but it’s insane. Stop, if that’s what you’re doing.
- Develop a goal and plan. Why are you investing? Your reason will decide your investment strategy. Review the plan annually or when conditions change. My preferred strategy is to buy stocks with a long history of strong fundamentals and paying dividends. I hold them, check fundamentals regularly, and market fluctuations don’t bother me as long as long-term fundamentals hold up. Remember, you win or lose only on the sale, not when the markets fluctuate!
- When the fundamentals of your investments change, confirm your strategy and sell even at a loss. The market could be down for several years, like the Japanese market, which has been below its bubble highs for over 20 years!
- Be proactive; know your risk profile, understand your portfolio mix and think long term. Don’t be swayed by generic asset combinations; you are unique and your combination should suit you at the stage of your life.
- If you are in the red zone of retirement, seven years to retirement, your goal should be capital preservation.
- Do not panic; although there is a point where, as in Japan, the market may not recover quickly. Focus on your goals and plan. They must be up-to-date and adjusted to your needs and your risk profile.
A key factor that we forget is that US consumer spending is roughly 70% of GDP. The Great Recession seriously hurt consumers. Today, they will not rush to spend recklessly as before. So in economies like the US that don’t create jobs, we should expect consumers with jobs to save, not spend like they used to.
And so US and global economic growth will be slow. This is the logical result of a previous excessive exuberance that led to the most recent bubble. Beware; more government stimulus sounds like good policy, but it will simply cause public debt to rise rapidly. It will not grow the economy. Patience must be our mantra!
Copyright (c) 2011, Michel A. Bell