Why are Markets so volatile?
Financial Markets have had some wild ups and downs during the first 4 month of this year. Let’s have a look at what is causing this volatility and what to expect for the rest of the year. The biggest economic development this year came from the US Federal Reserve, which raised interest rates for the first time in almost four years, after slashing them to near-zero at the onset of the Covid-19 pandemic. The move was expected—Fed chair Jerome Powell had been signaling a March rate hike since the winter, and investors took it in stride. Rising interest rates will or should cause a decrease in demand and are a tool to cool inflation. However, the concern is that the Fed may go too far and spark a recession. They have been misjudging the situation and fallen behind which could turn into an overreaction. The rapid speed of printing money, trying to mitigate the effects of the lockdowns, combined with supply issues from these lockdowns have created an imbalance of Money Supply and Product Supply. The excess of the former and the lack of the ladder is causing the current excessive inflation. While high inflation being almost always transitory, the hope of this being a short-lasting event has faded.
Meanwhile, Russia’s invasion of Ukraine continues despite intermittent peace talks and is threatening the European economy as well as American business investment and consumer spending. The uncertainty of how this will play out is contributing to the current volatility. The loss of production there in the oil industry could eventually lead to an oil price that is more of a problem for the overall economy. Volatility is usually spurred by uncertainty and until we can get some clarity, it will continue to dominate the bond and stock markets. Gold, which historically provided a hedge against market volatility has lost that ability and has been at the same level as it was 10 years ago, in fact gold has lost value if we factor in inflation. Bitcoin, a possible replacement for gold as inflation hedge got cut in half, most likely because of liquidity needs. People needed cash to make up for losses elsewhere, or simply to deal with the sky-high inflation. Real Estate and Commodities have been performing well as expected in a high inflationary period and Energy, which is one of the triggers for the high inflation has been outperforming.
While market volatility is unsettling, it is historically not unusual. If you have an appropriately diversified portfolio that matches your time horizon and risk tolerance, it’s likely that the recent market drop will be a mere blip in your long-term investing plan. However, I know that it can be hard to do nothing when markets are rough. Given what has been happening recently, consider some important investing principles:
· Don’t try to time the markets. It’s nearly impossible. Time in the market is what matters. While staying the course and continuing to invest even when markets dip may be hard on your nerves but will be most likely healthier for your portfolio and can result in greater accumulated wealth over time.
· Make sure you have a diversified portfolio based on your tolerance for risk. It’s important to know your comfort level with temporary losses. Sometimes a market drop serves as a wake-up call that you’re not as comfortable with losses as you thought you were, or that a portfolio you assumed was appropriately diversified in fact isn’t.
· Rebalancing. Market changes can skew your allocation from its original target. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio and moving the proceeds to positions that have become underweight.
· Build in protection against significant losses. Modest temporary losses are one thing, but recovery from significant losses can take years. Traditionally defensive asset classes, such as cash investments and short-term bonds, tend to perform better when stocks are down. When used for diversification, they can help buffer a portfolio against the effects of up-and-down markets.
Keep these things in mind since Markets could go much lower and we could have a year with negative returns. It is also very possible now that we see a recession within the next 2 years. None of these things are unusual. Markets have always worked themselves through these events and will do so again. In fact I think that 2022 will end up as an OK year, not a great year like 2021 but better than it looks now.
If you are trading stocks, options, futures, currencies or crypto, you are most likely bombarded with ‘advice’ from TV, Internet and social media. Much of it is biased and it has become difficult for the average trader to sort out the good guys from the bad guys. Keep in mind that nobody can predict the stock market and take any buy or sell recommendation with a grain of salt. Retail investors are now making up 25% of the stock market but 80% of them are losing money, mostly because of following the wrong sources.
Falk Hampel
