U.S. stock prices plunged Monday morning, further rattling investors, who had just gotten comfortable with a stock market recovery. Is the market going up–or down? Experts are divided.
The right answer is yes to both. U.S. stock prices are going to be highly volatile over the next several months–soaring and plunging until investors are completely queasy. The reason for the volatility is partly economic and partly the nature of Wall Street.
Wall Street professionals want to be a step ahead of the market. That way, they can justify salaries and commissions that might seem ludicrous to people who look at their long-term performance and wonder why they’re paying 1% or 2% of their assets to essentially get the same–or, often worse–returns as the market as a whole. But these professionals don’t know where the market is going now (or, arguably, ever), so they’re a lot like a group of Border Collies reponding to the inadvertent twitch of an epileptic. They shove the herd one way, only to switch direction at the slightest indication that they’ve gone the wrong way.
Why don’t they know where the market is going? Two reasons. While some people think the economy has bottomed, others maintain that’s unrealistically optimistic. The signs of recovery are subtle, at best. Even if things were getting better, there’s worry that the vast amounts of debt that the Treasury has taken on to support its bank bailouts and economic stimulus plans could drive up interest rates, and those higher rates could nip any recovery in the bud.
In other words, the economy is tenuous. And Wall Street insiders are not psychic.
The other reason is that stock prices look to be fair at today’s levels. U.S. stocks, overall, are selling for about 12 to 14 times earnings. That’s a little low by historic measures, but not particularly so if growth remains slow.
In a logical world, that would mean that prices should remain relatively stable, responding only to earnings news. But that would fail to account for the Border Collies. The collies get fed for moving the herd. Wall Street gets paid for doing the same. If you don’t trade, thousands of brokers don’t earn commissions. Their BMWs could be repossessed; their children could be forced in to the horror of public, rather than prep, schools. Heaven forbid.
Consequently, they’re barking louder than ever–pretending to know a direction and hoping like crazy that you’ll be moved by their every whim.
Don’t do it. Where relative calm in the financial markets is bad for brokers, it’s good for you. A host of academic studies, including a fairly charming one dubbed “Boys Will Be Boys,” confirm that the more you trade, the more you lose to trading fees, taxes and mistakes. You don’t have to be a sheep.
If you have a well-reasoned investment strategy, ignore the noise, regardless of whether it comes from CNBC’s Jim Cramer (who is, by the way, the world’s biggest buffoon as Wealth Logic’s Allan Roth shows here) or your local broker. If you don’t have a well-reasoned investment strategy, what are you waiting for?
