2007Mar Volatiltity - The Sky Is Falling

2007Mar Volatiltity - The Sky Is Falling

The past two weeks have been marked by renewed volatility in the equity markets. The end of February in particular was not kind to investors. A steep stock market decline in China on February 27 led to a world-wide panic that sent the US Dow Industrials down over 400 points – a loss of over three percent in one day. The crash also set a new record for trading volume, and had exceptional breadth – meaning that virtually every stock in every sector went down at the same time which is quite unusual. To give a case in point, all 30 stocks of the Dow fell, and the index of every major country was down as well. For most investors, there was simply nowhere to hide!

So what happened? Some commentators blamed a negative report on US durable goods orders. Most of the blame centered on the massive stock market crash in China and projecting fears of a global “meltdown.” These are scary words indeed. But are they justified? It is times like this when having an understanding of the forces that drive economic change helps us put volatile markets in perspective.

There was no specific “reason” for the US market to fall. Stock markets fluctuate wildly in the short-term, often with no apparent “cause.” Does one negative factory order really signal a crash in corporate earnings and a resulting bear market? And does one bad day in the Chinese stock market really mean that a sea change is about to sweep over the global financial system? It is hard to believe in such an argument.

In the real world, life goes on as normal. Workers and consumers in both the US and China continue to go to work and spend money. A few weeks from now, this entire scare will most likely be a distant memory. The last Asian meltdown started in 1997, and the Dow Jones Industrials Average dropped over 500 points in one day in October of that year. However, despite the economic calamity hitting Asia and the volatility in equities, the US went on to enjoy some of its best economic times and stock market returns in history in the years that followed. Why would this be the case? Because a one-day drop in market averages, even at extreme readings, is not the basis for fundamental economic change.

As investors, it’s easy to get distracted by short-term swings in market psychology, which can change directions faster than the wind. This is why it is essential to focus on the durable, long-term trends that ultimately matter the most. We are still in the midst of a long-term boom, driven by the economic power of the Baby Boomer generation as they move through the very predictable stages of their lives.

While markets will continue to ebb and flow, the general direction should be in line with that of the largest generation in our economy. As Boomers spend more, providing for their families and maintaining their current standard of living, economic indicators point higher.