For those who are closely attuned to the financial markets, you probably have noticed more movement in both stock and bond prices. While the stock market is still near record highs, this added volatility is probably creating some unease.
Frequently the media highlights changes in the Dow, an index of 30 stocks. Personally I prefer the S&P 500 index, which is a broader index and weights stock by market value instead of price, as the Dow does.
However, both indexes normally perform in a similar manner.
Recently there have been a number of days that the Dow has moved 200 points. However, with the index around 15,000 a 200 points move is 1.3 percent.
While a 1 percent daily move in the market is noticeable, typically moves more than 2 percent are signs of heightened volatility, which we have not seen.
That is why it is important for investors to focus on percentage changes, rather than actual points. 100 points may sound significant, but from a base of 15,000 it is not that big of a deal.
Also, earlier in the year we had a period of very low daily volatility, so the increased movement we are currently seeing should not be perceived as too unusual.
There are basically two areas of uncertainty in the market that have investors concerned. The first is Fed policy.
The Fed has been quite aggressive in purchasing government securities to provide ample liquidity for quite some time. As the economy is gradually stabilizing, there is a fear about the impact of the Fed withdrawing from the market.
The other area of concern is the international outlook. While Europe has been in a recessionary environment for several years, there has become heightened unease about growth in emerging markets. Countries such as China, India, and Brazil were rapid growers over the past decade, but are now seeing their economies soften.
The past year emerging markets have significantly underperformed the U.S. market, as many investors are withdrawing funds from these countries.
This trend has accelerated over the past month. For investors in U.S. companies’ international trends are important, since nearly 50 percent of earnings for companies in the S&P 500 are derived overseas.
A couple points to consider is that looking forward, emerging markets will grow faster than the U.S.
However, there will be times these economies will stumble, so an investor needs to realize the risk investing in these markets.
Therefore, if you are investing in countries with a greater risk profile, you need to take a long-term perspective plus the amount invested should not be disproportionately large.
The early part of the year was one of strong stock market returns with little volatility. This may have led to some investors becoming overly complacent. Investing involves risk, and your risk tolerance and time horizon should be the main factors in determining how much to commit to stocks.
When markets are calm, it is not a particularly good time to add to stocks, and likewise when markets become volatile you should refrain from panic selling. Presently markets have gone from a period of unusual calm to what I would categorize, as normal volatility.
Some may wonder if this is an appropriate time to be investing in international stocks, including emerging markets.
Certainly someone does get international exposure investing in U.S. companies, given their significant sales overseas.
However, international investing does improve diversification and gives the potential for greater growth with economies expanding faster than in America.
Clearly the period of underperformance of emerging markets may continue a while longer.
However, for a long-term investor who is willing to undertake some risk emerging markets still offer good opportunities. In addition these markets are less expensive relative to our domestic market.
For someone who is risk averse, or with a shorter time horizon he/she should refrain from these markets.