Volatility is back! And that is a very good thing for the stock market. As a 26 year old, I have seen very little market volatility in my investing lifetime. You wouldn’t know that if you happen to get a day off work and sit around and watch CNBC all day.
The talking heads to everything they can to stir up terror and unrest. Trump may be impeached! The tariffs will hamstring business! Biggest single day point decline in market history! The yield curve is inverted! No it’s flattening! Which one’s worse?! Both! They’re both worse!
I’m here to tell you to ignore the noise and keep right on going with your investment plan. If anything, I see drops in the market as buying opportunities.
Here are 3 reasons you should be excited when the indexes are in the red.
1. Volatility is necessary for a healthy market
As I said before, there has been very little market volatility in my adult life. I was 17 during the financial crisis, and the market has gone steadily up with little volatility since that scary “bottom”. These conditions are not normal. They are the aftershocks, even now, of the most aggressive economic policies in the history of the modern world. It is dangerous to become complacent and “comfortable” with unsustainable and unusual conditions that simply can not continue into the long term future. While it is true that the market always goes up in the long run, over time, it is not normal for the market to go up in a relatively steady straight line for a decade. It’s not normal for the market to break records daily. It is normal for the stock market to bounce around, and it’s a good thing. I don’t know how many money nerds there are like me out there, but the non-action in the market actually makes me more nervous than the volatility does. A Known threat is always better than an unknown one. I Know that volatility exists and over time you will become comfortable with it and see it as an opportunity. When the market goes up every single day for long stretches I find myself in a sort of “financial paranoia” state where I’m constantly looking for the next “big thing” that’s going to suddenly bring the whole house of cards crashing down in an instant. That’s obviously the overblown fear of a money nerd, but even a “normal” person can appreciate that temporary dips are a necessary evil.
2. Volatility shakes out the bad actors
Volatility has a tendency to shake out the people in the market who really don’t belong. I Always defer to my favorite investor of all time in these situations, Warren Buffett. He’s been one of the world’s foremost money managers for about half a century now, so there’s no shortage of quotes and soundbites that could drive this point home, but here’s my personal favorite on the subject.
When the tide goes out, you can see who’s skinny dipping.
This is one of my favorites not only because it’s an octogenarian talking about naked people, which is always funny, but because it’s a simple explanation of a complex concept. This is a play on the “a rising tide raises all ships” saying. When the market is like it has been in the past year, and every asset class seems to be flying up in a straight line, it’s easy for everybody to look like a genius for that time period. You may even be getting advice from people who have never handpicked an investment in their lives…but they made 20% in their 401(k) last year, so they’re pretty sure they’re a world class money manager now. But as Buffett says, when the tide goes out (or the bear market hits) you’ll see who’s skinny dipping. Those people who don’t have true, strong convictions about their strategy, and those who are leveraged to the hilt, won’t be able to stomach a 15% correction, and they’ll be shaken out.
3. Go shopping in the bargain bin!
“Bargain bin” may have been given a bad name by that terrible steel cage of Sharknado-esque DVD’s in the front of the supermarket, but it’s not all bad. The stock market tends to trade in lock step. “The stock market”, I think largely due to index funds, trades more like a broad “asset class” than as individual companies moving independently based on their daily value. This can be a huge advantage to an opportunistic investor. While it’s not typically a great idea for an individual to put a huge investment into stocks directly in the “blast zone” when bad news hits the market (think buying up bank stocks at the bottom of the financial crisis), the entire broad market typically drops even if it is completely unrelated and not impacted by whatever news item is driving the Wall Street drama of the day.
An example from a recent news item would be the announcement of the steel and aluminum tariffs coming down. While those tariffs will possibly have a large impact on high overhead low margin steel and aluminum dependent businesses (like automakers for example), or businesses that do a large portion of their business in China, tariffs will have No measurable impact at all on the Vasty majority of the market. That being said, on the back of that news, I’d say close to 90% of publicly traded large cap stocks took a plunge that day. Some for absolutely no reason, other than the fact that “stocks were down”. Those would be stocks that are On Sale!
Another way that a stock is sometimes “on sale” is when a negative piece of news is so overblown by the media that it drags a stock down a large amount in spite of it being a relatively small impact on the actual business. A recent example of this would be the Wells Fargo asset growth restrictions enforced by Fed chair Janet Yellen on her way out the door. On the back of that news, in addition to a market wide sell-off, Berkshire Hathaway (a massive holder of Wells Fargo) lost nearly 12% of its value in a few days. Wells Fargo represents about 10% of Berkshire’s portfolio. Wells Fargo’s stock also dropped about 12%. Do the math. A 10% loss for Wells should have resulted in about a 1% change in Berkshire’s share price. The negativity and sensationalism of the media gave you a great buying opportunity for one of the best performing stocks of the past century.
Ever had a good or bad experience will volatility? Ever been caught financially skinny dipping? (or actually skinny dipping I guess??) Share in the comments below!