September 12, 2016

Is This Panic Any Different?

The S&P 500 fell 2.4% on Friday and the Dow Jones Industrial Average followed with a 2.1% dip, both dropping below their 50-day moving averages. This was the first 1% selloff since June and the press portrayed the move as a real market selloff and reason to hit the panic button.

So what triggered this?  Efforts to discover why traders ran for the hills on Friday turned up two culprits.  The first was Boston Federal Reserve President Eric Rosengren’s announcement on Friday that there was a “reasonable case” for raising interest rates in the U.S. economy.

If the Fed decides the economy is healthy enough to endure another rise in interest rates (which keep in mind are still at historic lows), why would this be bad for the stock market?  Any rise in bond rates would tend to make bond investments more attractive than stocks and tempt some investors to sell stocks and buy bonds.  However, given that dividends from the S&P 500 stocks currently average 2.09% and the 10-Year Treasury yields 1.69%, this might not be the wisest trade.

If the possibility of a 0.25% rise in short-term interest rates doesn’t send you into a tailspin, then bond guru Jeffrey Gundlach’s perspective might alarm you.  According to Gundlach, “Interest rates have bottomed. They may not rise in the near term as I’ve talked about for years.  But I think it’s the beginning of something, and you’re supposed to be defensive.”  Short-term traders appear to have taken Gundlach’s statement to heart and prompted automatic trading programs to react by selling equities.  After the computers brought the market down by 1% last week, human investors took note and started selling as well.

However, all this noise about a 2% drop after a long market calm simply tells us that we are experiencing normal market volatility.  This is usually pretty good news for investors because volatility has historically provided more upside than downside and these sporadic downturns provide an opportunity to actually add to your stock portfolio at lower prices.

We don’t know how the market is going to react this week or whether the Fed will raise rates later this month.  What we do know is that there have been several temporary panics during this bull market run that started back in March of 2009.  Selling out during any of those panics would have been a mistake.  The U.S. economy is showing no sign of collapse, job creation is stable and a rise in interest rates from near-negative levels would probably be good for long-term economic growth.

Bottom line:  Panic seldom benefits the long-term investor. Don’t try to convince yourself that this time is any different.

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