How To Stop Worrying And Love Market Volatility

Karl Kaufman

“Buy the ticket, take the ride,” wrote Hunter S. Thompson in his classic book Fear and Loathing in Las Vegas. Equity investors have been on a bumpy ride this month as volatility, lying dormant for what seems like an eternity, returned to the market in force. Wild swings in the Dow — thousand point drops followed by triple digit gains followed by drops and then gains — erased much of January’s returns and then some.

What’s behind all the action? Ask six people their opinions and they’ll give you six different answers:

“The bond yield and interest rates rising”
“Janet Yellen burning bridges on her way out”
“Algorithms”
“Inflation fears”
“The memo”
“The Eagles winning the Super Bowl”
Whatever the reason, after the near steady rise in equities over the course of 2017, where not even the threat of nuclear war could spook the market, suddenly fear and loathing on Wall Street have returned.

The talking heads and much of the financial media have been asking “Is the market overpriced?” or “Are we overdue for a correction?” The sell-off that took place last week then becomes a self-fulfilling prophecy as panic selling dragged the market down. Fear is a more powerful emotion than greed, and making investment decisions based on emotions are short-sighted and foolish.

Warren Buffett’s oft-quoted advice to ”be fearful when others are greedy and greedy when others are fearful” certainly has some contrarian merits to it, yet it’s much better to leave emotions out of investment decisions. If you’re a long-term investor following the crowd and selling into a panic, ask yourself why you’re selling and why you bought a stock in the first place. What has changed between now and then? If you get spooked so easily and can’t stomach volatility, maybe you shouldn’t be in stocks to begin with.

I used to ask my late grandfather for investing advice, and he would look at me slyly and say “Buy high, sell low.” He meant it as a joke, yet for many investors the joke has been on them this month. FOMO (Fear Of Missing Out) in January caused investors to drive prices up to record highs. Yet, at the first sign of a market correction they were out the door, following my grandfather’s puckish advice.

The herd mentality of market participants is irrational, counterintuitive and counterproductive. Imagine a clothing store raises the price of jeans by 50% year over year, and customers line up outside the door to buy a pair. One month later, the same store offers to buy back the same jeans (unworn, of course) for 10% less than what they sold them for and they become inundated with sellers. No rational consumer would behave in such a way, yet this scenario is somewhat comparable to what happens during market upswings and downturns.

Obviously, it’s better to buy stocks at discounted prices, and the market’s valuation hasn’t been this low for quite some time. The economy is good, earnings are good, fundamentals are good. Tax reform is a once-in-a-generation opportunity for businesses and their investors.

So why has the focus shifted to the claim that 3% 10-year Treasury rates are a market Armageddon? Was this a concern 2 weeks ago? Rates are still historically low as we’ve had easy money for ten years. However, the narrative has to find a reason for the sell-off and groupthink once again rears its ugly head.

It’s important to have some proper perspective on interest rates. On October 19, 1987, when the Dow had its largest one day drop (percentage-wise), the rates on the 10-year Treasury bond was 10.22%. According to MarketWatch, “in the months leading up to the October crash, the interest rate on 10-year Treasurys jumped about 45%.” If something similar were to occur in the near future, perhaps that would be the time to start getting nervous.

Fear of inflation is a valid reason for the February jitters. The tax cut has added fuel to the growth of an unshackled economy, and rising prices coupled with a weaker dollar have many people worried about the risk of inflation. This Wednesday’s release of the Consumer Price Index numbers could put the market back into sell mode if the numbers come in too high.

Stocks are usually a long-term hedge against inflation. The money under your mattress loses purchasing power over time and bond prices drop as yields rise, but the majority of equities tend to appreciate when held long-term. Watching your stock investments rise and fall over time, however, requires patience, discipline, and an ample amount of fortitude.

Last Monday, the Dow dropped below its 50-Day Moving Average, triggering sell indicators for robo-advisors and other algorithms. This led to a drastic acceleration in the sell-off, causing the Dow to lose 800 points in a matter of minutes before recovering somewhat by the end of the day. I had warned about this possibility in a previous article discussing the dangers of passive investments such as index funds and ETFs, and sure enough, commentators were blaming algorithms for the sharp decline.

Investors had gotten complacent and had grown accustomed to a smooth upswing in equities with very little deviation. Market corrections are fairly regular occurrences and signal a healthy market cycle. You can protect yourself from volatility by buying stocks with low betas and high dividends. You’ll still collect income during market downturns and when prices drop, yields go up. To paraphrase the subtitle of Dr. Strangelove, that’s how I learned to stop worrying and love market volatility.

Buy the ticket, take the ride.

This article was written by Karl Kaufman from Forbes and was legally licensed by AdvisorStream through the NewsCred publisher network.