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Is Volatility Really A Concern?

  • 2000 5 May
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Is Volatility Really A Concern?
Reprinted with permission from World Finance Net IPO Newsletter, written by Alexander Frauenfeld

Ever since the stock markets nosedive in March, investors have had a bad case of the jitters. The fear is that Wall Street's generous bull may transform into a vicious bear. And there is plenty to worry about: the Federal Reserve is on the warpath, raising interest rates to fight inflation. Asian stock markets are still struggling to pull themselves out of tailspins started by their financial crisis in 1997. And European markets are taking it on the chin, as the Euro sinks.

What is really shaking up investors, though, is market volatility. Point swings of 100 points or more have become the norm, rather than the exception, on the DOW as well as the NASDAQ. Today saw another 150 point dump on both indices. Usually such high volatility hits when a crisis or recession is upon us, but such is not the case today.

In fact, the volatile swings could be following a boom-then-digest pattern that became the prevailing way of the 1990s.

The idea behind this pattern is that a bull market moves as investors react to information that either verifies or suggests new trends. Once the new information is factored into the markets, and everyones stock price has accelerated, investors enter a waiting phase to see what will happen next, and that inactivity creates a leveling off of stock prices. That stagnant phase can generate fear among investors accustomed to stocks going up, and that fear leads to volatility.

After the recent slump, it may be about time for investors to begin buying some of the modestly undervalued stocks and start pushing the markets higher once again. Some of the sectors have been cleaned out of those companies that will most likely not make it in the long run, and investors are now able to selectively buy companies for the long-haul.

Additionally, earnings are still forecast to be very strong. Several experts are of the opinion that operating profits for S&P companies should increase by approximately 10% this year. The general sentiment on the Street is that the longest economic expansion in US history is not about to fold, giving investors even more confidence in the equity markets.

What about the Fed tightening? Well, what about it? Current rate increases are already factored into the market, that is, they are expected, and economic numbers seem to support the belief that the Federal Reserve has succeeded in slowing the economy with its previous 5 tightening moves since the summer of 1999.

Though we might not get to see the mind-boggling climbs in the DOW and NASDAQ that we had the pleasure of watching for most of 1999, a more realistic rise in line with the rise in earnings and cash flow should be observable in the future. Completely unrealistic valuations, seen with some of the Internet issues in the recent past, might be just that: history.

Volatility, which some say has tripled and is higher than it was during the Gulf War Crisis in the early 1990s, is up for another reason. It reflects the fact that there is less of a margin for error than there used to be. Investors are more easily upset by bad surprises, now that stocks are trading closer to their fair value.

What To Expect
There is no sign that all this volatility will slow down any time soon. The markets should trade in a rather narrow range for a couple of months to come, while the interest rate scenario is getting resolved. Besides continuous discussion of what the Fed might or might not do in the future, there just does not seem to be that much interest out there. The next big indicator will be the upcoming earnings season in July.

The tug-of-war between the major positive in the market (strong earnings) and the major negative (rising inflation pressure) will continue until investors can eventually figure out which one the markets will settle on. Investors will face a lot more stomach-turning market moves before Wall Street is ready to once again astonish us with nice returns on a regular basis. The best advice for now is to just hold on.

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