Vol. 3, Issue 3August 2011


Why is the stock market so volatile lately?

Robert Rahaim, CFP(R)

Many people are asking DeSERANNO: “Why is the stock market so volatile lately?” ““How does the recent stock market volatility affect me?” And, “What should I be doing with my money now?” In this article I am going to explain what has made the stock market so volatile over the past few weeks. Then, I will tell you how this affects you. And finally I will offer some advice about what you should do now.

“Why is the stock market so volatile lately?”

The three major factors driving the recent stock market volatility are the credit rating downgrade of U.S. Treasuries, the pace of economic growth in the U.S., and the debt situation in Europe.

The stock market reacted negatively to the recent downgrade by Standard and Poor’s of the U.S. debt to AA+ from AAA status. However, since the downgrade, interest rates on these securities have actually fallen and their price has risen. Usually a credit downgrade results in rates rising (higher borrowing cost) and prices falling, but the U.S. Treasury market is still seen as a safe haven (as it should be). Also, we already knew the current budget deficit is a problem (we borrow $0.40 of every $1.00 currently spent) and the entitlement programs such as Social Security and Medicare are not on sustainable paths and are in need of reform. But that won’t happen until the political will exists to make changes. The other two major credit rating agencies have reaffirmed the AAA rating. Even though many stock investors reacted negatively, the Standard and Poor’s downgrade of the U.S. debt has proven not to be an actual negative

The next major factor causing investors to sell stocks is that recent economic indicators showed the U.S. economy has been in a slow growth state for the last several quarters and unemployment rates have remained stubbornly high. At the same time corporate profits from the largest US Companies have been ahead of expectations for the past several quarters with expanding profit margins. These diverging messages contribute to a lack of clarity and uncertainty surrounding the economic recovery and expansion. The stock market does not typically do well in times of uncertainty.

The last major factor driving recent stock market volatility is the debt situation in Europe. Banks in Europe are anxious and fear default as they own significant amount of bonds from financially troubled countries such as Italy, Spain and Greece. The debt issues in Europe are not new and have been brewing since 2009. The markets are reacting to a lack of certainty regarding what the European Central Bank is planning to do to help stabilize the bond and currency markets.

“How does the recent stock market volatility affect me?”

For the average investor who has a solid financial plan that includes a specific purpose for every investment they own, these events create temporary uncertainty but have little bearing on the probability of a successful financial future.

Young or middle aged investors with a solid financial plan are putting money into the stock market and not out. These savers actually now have an advantageous opportunity to buy stocks at lower prices.

Those investors closer to starting or already into the next phase of their life (formerly known as retirement) with a solid financial plan already have their investments set up to fund their income needs today and in the future regardless of stock market fluctuations. These investors should be able to whether any stock market fluctuations utilizing strategies including building bond ladders with U.S. Treasuries to supplement Social Security and pension income for 10 to 15 years into the future.

“What should I be doing with my money now?”

For young or middle aged investors the most important factor contributing to a successful financial future is one’s rate of savings in relation to income. Maintaining a savings rate of 10-20% of income over one’s lifetime is imperative to build a successful financial future. Adequate savings going into the stock (and bond) market on a regular basis has always led to a successful financial future.

For older investors, or investors of any age for that matter, with a solid financial plan in place, unless your goals have changed there is no need to change investments at this time.

These conclusions of course beg one additional question:

“What do I do if I don’t have a solid financial plan in place?”

Get one.