Why do markets move?
Given the heightened volatility of the last month (and yes, I realize you can put that opening in the “understatement hall of fame”), it’s important to go back to the basics on an understanding of market mechanics and what it means to us as long-term stock investors.
The first fundamental point to remember is that every time someone buys a stock, someone is selling that same stock. Two parties have agreed on a price that is attractive based on their respective opinions about the future trajectory of that stock—I thought it was good to buy at $100 and you thought it was good to sell at that price. One of us will end up being correct.
So why are market prices constantly adjusting? Two reasons:
- New information has entered the public sphere, and/or
- Investors are changing their future expectations.
What we’ve seen over the last month is an influx of rapidly changing information (each day feels like two weeks or more in the news cycle) and rapidly changing investor expectations. The combination of these two things has heightened the magnitude of the price changes, but it’s not fundamentally different than any other time in the market.
The Dow this month has experienced some of its worst days in history and some of its best, including the best single day since 1933 (the Dow, of course, is a bad measure of an investment portfolio, but we’ll save that for another blog post). Are we really learning enough new information to justify 10% price swings in a single day? Said another way, is a share of the market’s future profits over the long haul really worth 10% more or 10% less based on one day of news? Or, are investors trying to cope with an unprecedented event and wildly swinging their expectations day-to-day? It’s impossible to know for sure, but it’s certainly a fool’s game to guess about tomorrow. As I write this, the Dow is at roughly the same level it was two weeks ago on March 12. Over those two weeks, we have seen down days of nearly 10% and 13% and up days of 9%, 11%, and 5% twice.
So what do we make of this volatility as long-term investors, and what should we do about it? When we talk about changing investor expectations, keep in mind that it is short-term speculators who drive daily market movements. Their time frame is maybe a year, months, weeks, or even minutes, and in that sense the wild price swings probably make sense.
But for a long-term investor, volatility like this is noise. It can certainly be deafening noise, especially when amplified by other concerns like the serious health scare we are all dealing with now, but for our long-term financial plan it is still just noise.
The answer is to focus on what we can control – stick with a disciplined plan and take advantage of the rebalancing and tax-loss harvesting opportunities that come – and to focus on what we can predict accurately – continue to invest in stocks for the long-term and have confidence that companies have always found ways to be profitable through every environment and that economies will grow over time.