Volatility is back. Just as many people were beginning to think markets only move in one path ever, the pendulum has swung the other way. Stress is an all natural response to these events completely. Acting on those emotions, though, can finish up doing us more harm than good. There are a variety of tidy-sounding theories about why marketplaces have become more volatile. Among the problems frequently splashed across newspaper front pages: global growth fears, policy uncertainty, geopolitical risk, and the Ebola disease even.
In many instances, these presssing issues aren’t new. The US Federal Reserve gave notice last year it was contemplating its exit from quantitative easing (an unconventional monetary policy utilized by central banks to stimulate the economy when standard monetary policy is becoming ineffective). Much of European countries has been struggling with sluggish downturn or development for a long time, and there are always geopolitical tensions someplace.
In some ways, the upsurge in volatility in recent weeks could be as much a reflection to the fact that volatility has been very low for some time. This season with a low price on risk Traders in aggregate were satisfied earlier, but now these are applying a higher discount rate to risky resources.
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So the upsurge in market volatility can be an expression of doubt. Markets do not move around in one path. If they did, there would be no return from buying stocks and shares and bonds. And if volatility forever remained low, there would become more reason to worry probably. As to what happens next, no one knows for certain. This is the nature of risk. In the meantime, traders can help control their risk by diversifying across and within asset classes broadly. We have seen the benefit of that in recent weeks as bonds have rallied strongly.
1. Don’t make presumptions. Understand that markets are unpredictable and do not always react the way the experts predict they will. When central banks relaxed monetary policy during the crisis of 2008-09, many analysts warned of an inflation breakout. If anything, the change has been the case with central banking institutions fretting about deflation.
2. Someone is buying. Quitting the collateral market when prices are falling is like running away from a sale. While prices have been reduced to reveal higher risk, that’s another way of stating expected earnings are higher. And while the mass media headlines proclaim that “investors are dumping stocks,” keep in mind someone is buying them.