The Day After

The stock market declined by 2.5% today in morning trading. The initial decline of about 1% seemed to be based on concern over a reduction in growth forecasts for the European economy, but then, after a brief rise in values, the decline continued. Various pundits are now trying to make the case that the election result is the cause of the drop, because of the potential of increased taxes, increased regulation, and increased likelihood of hitting the fiscal cliff. This explanation seems unlikely for two reasons. First, none of the pre-election analysis – and there was plenty of pre-election analysis – suggested that any of those factors would cause a change in fundamental values across the entire market. Many analysts believed that financial and energy stocks might be negatively affected, and healthcare stocks would be positively impacted, but there were no predictions of a decline in overall values. Second, and more importantly, there was an active futures market overnight, and if the election result was truly the cause of this decline in value, it would have shown up about 8:30 Pacific time last night. Indeed, initially, the S&P 500 futures contract rose about 1% in value, and remained there until the European markets opened.

So, what happened? Perhaps the optimism that triggered yesterday’s rise in values, upon further reflection, seemed unwarranted. Maybe the drop in European stocks caused greater concern of a worldwide recession. However, sometimes short-term market movements defy any logic. While it’s not a very satisfying explanation, it seems better to admit that we don’t know the specific cause of a market movement than to create a reason that clearly isn’t valid. During last year’s extreme market volatility caused by the Greek debt crisis, we wrote frequently on the lack of justification for the extreme stock market movements that were occurring. Our suggestion at that time was for investors not to panic, and to maintain their long-term strategy. Those who stayed the course were rewarded with over 30% returns on the S&P 500 over the next year (between October 1 and September 30). We have the same recommendation today. A 2% daily change in values is not unusual – indeed, during the second half of last year, it happened quite frequently.

We never know exactly what the future holds. We have enjoyed an incredibly calm stock market over the past 10 months. Today is a reminder that sharp market movements can arise at any time – stocks have risk, and they always will have risk. Moreover, we know that when volatility occurs in the market, it is often followed by several days of heighten volatility. So it would not surprise me over the next few weeks for us to continue to see sharp fluctuations in stock values. But if you’re invested in stocks, you are in them for the long-term, and modest movements in values over the short-term should not dissuade you from your overall strategy.

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