Stock market volatility has returned with a vengeance. In the first 14 trading days of 2015, the
What's behind all the volatility?
One cause is simply a feeling that the U.S. stock market is overdue for a correction--or worse. The last bear market ended on
Then there's everyone's favorite economic guessing game: What will the Fed do? The Federal Reserve is expected to raise short-term interest rates later this year, which would be the first hike since 2006. Higher rates are generally considered negative for both the stock and bond markets.
But the primary causes for the most recent anxiety are the plunge in the price of oil and the
Why is there so much confusion and uncertainty?
The impact of these economic events cascades over scores of other issues, from consumer spending and corporate profits to global politics and monetary policy. Identifying who and what might be impacted, how the impacted parties will react and whether that will cause a second cascade of reactions is complicated and prone to error.
Consider the potential fallout from just one of the recent news events--the collapse in oil prices--to illustrate how complex the questions can be. Since last June, the price of a barrel of oil has plunged 55% because of oversupply and sluggish demand. That's a boon to U.S. consumers, who are likely to save an average of
The flip side of the oil bust is lower profits--or none at all--for energy companies, especially oil and gas producers that had created tens of thousands of jobs in recent years. That has already resulted in large layoffs in oil-rich states, such as
Meanwhile, the collapse in oil prices is reverberating through both the stock market and the junk bond market. Energy stocks are 8% of the S&P 500 index, and debt issued by energy firms accounts for 16% of the U.S. junk bond market. From its peak last summer through
The oil rout also has global political implications. It puts pressure on oil-producing nations, including such U.S. adversaries as
In truth, we care more about the euro, which crashed after the
Moreover, the euro's drop is likely to hurt U.S.-based multinationals with operations in
One reason the franc is so much stronger than the euro is that Switzerland's economy is in much better shape than the eurozone's. In fact, much of western
What's so bad about deflation?
Two things. First, when prices fall, both companies and consumers tend to delay major purchases because they expect lower prices in the future. But such behavior can turn into a self-perpetuating economic tailspin, with prices falling in the wake of lackluster demand and demand drying up as customers wait for prices to fall more. That stops companies from producing products and leads them to lay off workers, who then cut back on their spending and further fuel the downward spiral.
Deflation also makes it harder for a central bank to boost an economy by cutting interest rates, says Johnson. In a normal, growing economy in which prices are rising modestly, dropping interest rates can stimulate growth because a cut results in lower after-inflation borrowing costs. But in an environment in which prices are falling, trimming rates does little to encourage more economic activity if consumers and businesses expect to pay less for goods and services in the future.
All that said, the
Do these deflation fears hasten the arrival of a bear market and put my investments at risk?
We do not anticipate a bear market. With most parts of the U.S. economy humming, we are sticking with our forecast of low-double-digit percentage gains for the broad U.S. stock market in 2015.
Still, it does seem likely that U.S. markets will remain volatile--swinging wildly both up and down--for several months while the market mulls the longer-term impact of a strong dollar, weak oil prices and economic uncertainties in
Should investors do anything differently in this environment?
Because there are no certainties in investing, you want to make sure you have enough cash to handle any near-term goals. A prudent move is to review how much you have in cash-type investments, such as money market funds, bank accounts and short-term Treasury bills and certificates of deposit. If you don't have enough cash, consider raising some by selling some of your stock holdings. Additionally, having a bit of extra cash can allow you to capitalize on buying opportunities when shares of good companies get trashed in a short-term sell-off.
If you employ stop-loss orders to manage risk in your portfolio, you should know that volatility makes them a risky proposition. That's because these orders tell your broker to automatically sell if prices dip below set thresholds, but in a volatile market that dip could be momentary. If you haven't reviewed your stop-loss orders lately, now is a good time to talk to your investment adviser about what makes the most sense for your particular situation.
It may also be smart to prune your portfolio, says
What about bonds?
If you own a high-yield bond fund, you might want to consider paring back. As mentioned, energy companies account for a disproportionate share of the junk bond market. Their ability to repay that debt is likely to hinge on how much debt they carry and what happens to oil prices.
Otherwise, don't rush to make drastic changes in your bond holdings. The Fed remains on course to raise rates in the U.S. later this year, but it won't raise rates by a lot, and the first hike might not necessarily signal a lengthy regimen of increases. Moreover, short-term rate hikes engineered by the Fed don't guarantee that long-term yields, which are set by investors in the bond market, will rise in tandem.
Comment by clicking here.
Kathy Kristof is a contributing editor at Kiplinger's Personal Finance magazine.