Foster Group

We have a children’s book in our house titled, “The Way I Feel” that encompasses the range of emotions kids seemingly go through on a routine basis; happy, sad, excited, angry, fearful.  Ironically, I think we adults experience these same emotions in our daily lives, perhaps even more than our kids.

The current renewed volatility in financial markets is reviving unwelcome feelings among many investors – ultimately creating a sense of powerlessness.  The sovereign debt strains in the US and Europe, renewed worries over financial institutions and fears of another recession are leading market participants to apply a greater discount to risky assets. It’s reminiscent of the fall of 2008 and early 2009, when the collapse of Lehman Brothers and the sub-prime mortgage crisis triggered a global market correction. This time, however, the focus of concern has turned from the private sector to public-sector balance sheets.  The personified markets are expressing their uncertainty and anxiety!

As for what happens next, no one knows for sure; that is the nature of risk.  But there are a few points investors can keep in mind to make living with this volatility more bearable:

Markets are unpredictable and do not always react the way “experts” predict they will.  The recent downgrade by Standard & Poor's of the US government's credit rating actually led to a strengthening in US Treasury bonds.

Quitting equity markets at a time like this is like running away from a sale.  Prices have been discounted to reflect higher risk, which is another way of saying future expected returns are higher. And while the media headlines proclaim, "Investors are dumping stocks," remember someone is buying them; there is no such thing as “orphan shares.”

Market recoveries can happen as abruptly as did the prior correction.  Recall that in March 2009 - when market sentiment was last this bad - the S&P 500 reversed course and put up seven consecutive months of gains totaling almost 80%.  This is not to predict that a similarly shaped recovery is imminent now.  Rather, it’s a reminder of the danger, for long-term investors, of turning paper losses into real ones and paying for the risk without waiting around for the recovery.

Markets and economies are different things.  The world economy is forever changing, and new forces are replacing old ones.  The IMF noted in its April 2011 World Economic Outlook that while advanced economies seek to repair public and private balance sheets, emerging market economies are thriving.  A globally-diversified portfolio takes account of these shifts.

Nothing lasts forever.  Just as smart investors temper their enthusiasm during booms, they maintain a degree of optimism during busts.  And just as loading up on risk when prices are high can leave you exposed to a correction, dumping risk altogether when prices are low means you can miss the turn when it comes.

Market volatility is worrisome. The feelings generated are completely understandable.  But through discipline, diversification, and understanding how markets work, the ride can be bearable.  At some point, value will re-emerge, appetite for risk will re-awaken and, for those who acknowledged their emotions without acting on them, relief will replace anxiety.