What is happening in the global stock markets? Experts have proposed specific reasons for the sharp swings, including the downgrade of the US credit rating, sustained high unemployment and declining consumer confidence. I’ll take a more generic look and then suggest an approach for individual Registered Retirement Savings Plan (RRSP), 401K or equivalent investors to weather 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 swoop in and take off; only to get out after that hope is dashed!
Also, investors are like sheep. When the market is steadily rising, investors follow other investors and buy stocks and bonds simply because others are buying. This herd mentality leads to market bubbles like the dot-com debacle. Then people realized too late that they had grossly overvalued stocks like Nortel and Yahoo!. When these bubbles burst, a massacre begins. Panic and irrational selling begins on a large scale, creating a value investor’s dream.
In general, what is happening today? Uncertainty prevails in all major economies. European economies are in trouble. The major surgery needed in Greece will see them stall for years as they grapple with the results of previous heavy government involvement in the economy. In addition to Greece, the EU rescued Portugal and Ireland. Now market players worry about France, one of the first rescuers. And let’s not forget that in the UK, the coalition government has a huge job to do to fix that messy economy.
And then there is the United States. Spending beyond their means, divided legislature, in the midst of electoralism. This is a perfect uncertainty formula. So, fasten your seat belts and get ready for a bumpy ride for the next two years.
What can people do in this investment environment? Be cautious; 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 equity funds
- Avoid day trading; It’s not just stupid, it’s crazy. Stop, if that’s what you’re doing.
- Develop a goal and a 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 stick to them, review the fundamentals regularly, and market fluctuations don’t bother me as long as the fundamentals hold up over the long term. Remember, you win or lose only by selling, not when 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, as the Japanese market has been below its bubble highs for over 20 years!
- Be proactive; Know your risk profile, understand your portfolio mix and think long term. Do not be influenced by mixtures of generic assets; you are unique, and your mix should fit you in your stage of life.
- If you are in the red retirement zone, seven years to retirement, your goal should be capital preservation.
- Do not panic; although there is a point where, like in Japan, the market might not recover quickly. Focus on your goals and plan. They must be up to date and tailored to your needs and risk profile.
One key factor we forget is that US consumer spending is roughly 70% of GDP. The Great Recession severely hurt consumers. Today, they will not rush into spending 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 the previous exuberance that led to the most recent bubble. Beware; more government stimulus sounds like good policy, but it will simply increase public debt rapidly. It will not grow the economy. Patience must be our mantra!
Copyright (c) 2011, Michel A. Bell
