As markets have now evolved into trading violently up and down by hundreds of points, some are asking whether there are new forces, new rules, which appear to govern stock market behavior?
Obviously, it has become more possible for stock averages to appear to make "large" swings....what used to be 3 or 4 percentage points thirty years ago was a number in the single digits. At 17,000 on the Dow Jones today, one percent is already a three-digit integer.
The
question is whether this volatility is a "problem" that frightens
away investors, or simply an uncanny opportunity to profit from big
swings. Without implying that either
scenario is good or bad, I do believe that we can ascribe a certain amount of
stop-and-start behavior to the advent of technology and computerized trading
programs. Irrespective of fundamentals
or long-term objectives, the machines are programmed to execute at valuation
ranges which condense the aperture of analysis.
I know, because I am also the architect of such a data base.
The
difference, though, between systematic "black box" investing and
private client money management is that real
people have real tolerances for risk, and a set of expectations about normal
market behavior and trend patterns, whereas computers don't....or don't need
to...factor emotion into their models.
That's unfortunate
Since
the onset of computer trading, the frequency of 4 percent (or more) moves in
market averages has increased by several standard deviations above the
frequency of their occurrence before the year 2000.
Regulators
and legislators have noticed this change, and are highly curious, and critical,
about computer's connections to market volatility. It hasn't gone unnoticed that there is a more
pronounced decoupling from long-term fundamentals in today's financial markets,
even as the impact of directional changes wreaks havoc upon the psyche and
confidence of retail market players. The
past decade and a half has been one of the most volatile in market history,
while the aggregation of the most severe of those percentage gains/losses has
happened only in the last decade.
Recoil
or attack?
The
best thing the "average" investor can do is to ignore the haze of
exogenous noise, because trend lines tend to even out the extremes. As we have experienced with client
portfolios, the numerical net-net of recent calamitous upside/downside volatility
has only approximated "zero" change during a protracted period of
time. It happened previously during a
half-decade of S&P performance (2003-2008), and it occurred again subsequent
to this summer's downside capitulation followed by the past few weeks'
bounce-back. If you don't have a money
manager who produces incremental upside gains during these fallow periods,
you're not following the right disciple.
For example, buying an index tracking fund and expecting anything
different from the net index performance is being unrealistic.
Unfortunately,
the drag on investor psychology and behavior caused by these sudden eruptions outweighs
any euphemisms I might write about. Once
the markets lose investor's confidence and trust, it is tough to regain
it. Financial institutions and
individuals have tested the patience of clients for too long. "New
normal" or not, the markets
have been alienating their target customer base with impunity, portfolio gains
notwithstanding.
In
a sense, this is a morality play at work....the struggle between moral
persuasion versus technological efficiency.
But
when the empirical laws of economics break the bond of trust and ethical
behavior, one unfortunately runs out of fiscal or monetary solutions to repair
the breach. No doubt, profits are
good. But we have not really addressed
the notion that some profits are more socially
productive than others. It's also
time we look at how the trend of increasing profit margins has, or has not,
improved our quality of life.
One
is always aware of the influence of exogenous and non-numerical factors upon
data and market analysis. In like
fashion, trying to manipulate vast secular (generational) momentum is analogous
to turning a battleship in a bathtub...very difficult to do. The most critical element to all portfolio
and economic analysis is time...time
to remediate and effect trends; time to mobilize computer data; time to
strengthen moral values; time to skew the politics of power; time to scrutinize
the influence of business ethics; time to sit back and put things into
perspective.
But,
hey, who's got time for anything nowadays?
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