October was an anxious month for investors as the US market fell 7% while the Australian market fell by about 5%.
There was no single major reason for the decline as the US economy grew at an annual rate of 3.5 per cent in the third quarter and corporate earnings are strong.
This is tempered with ongoing concerns about the US-China trade war and rising US interest rates.
Obviously a lot of information crosses our desk when markets increase in volatility. For getting a solid insight, this article from Bloomberg columnist and New York investment adviser Barry Ritholtz, was something that I’d like to share with 5 insights as to why markets declined last month:
1. Unusually high gains in 2017:
Not only were the double-digit increases much stronger than the median returns over time, they came about with almost no volatility. My best guess is that a market that leaves 2018 with little or no gain simply represents mean reversion at work.
And, that’s a great deal! Imagine the God of Trading came to you and promised 20 percent gains in year one, followed by no gains in year two. You would take that offer in a heartbeat.
2. Higher market volatility often follows after Low market volatility
The move from low volatility that we saw last year, to higher market movements up and down this year is a cyclical phenomenon we have seen time and time again.
3. Extreme optimism
The US market and economy has been buoyant with record company profits, national tax cuts, new deregulation of industries, low interest rates and low unemployment – there’s little bad news.
As Barry writes in his Bloomberg column, “When stock prices are at record highs and the crowd is enthusiastic, Mr. Market will do what he can to humiliate investors. As legendary investor Bernard Baruch said, “The main purpose of the stock market is to make fools of as many men as possible.”
4. The era of cheap money is ending
The post GFC period of zero interest-rate policy ended three years ago and the Federal Reserve continue to inform the markets that the interest rates will be rising in the short and medium term.
Continued concerns with strong economic numbers and trade wars could see interest rates increase faster than expected, which would impact the profitability of companies on the market.
5. The global economy is slowing
Growth in the major economies is losing steam. Whilst this doesn’t mean that any catostrophe is going to occur, the significant impetus of tax cuts, record profits and share buybacks are already priced in to the value of the markets.
Where to Now?
Barry writes, “With all of those factors already incorporated into share prices, what is going to drive the next move up in markets?
I have no idea, but candidates include further economic expansion, more deregulation, another tax cut, increasing innovation, more buybacks, higher dividends and rising profits. But what if none of those materialise?
Baruch also famously said, “I made my money by selling too soon.”
Most of us are not Baruch, in which case it is probably too late to sell and too early to buy.
Unless you have done nothing amid all the noise and commotion, in which case you will end up ahead of almost everyone else in the long term.