Lessons From a Wild Week on Wall Street

The week ending October 17 saw wild movements in stock prices. Is such volatility normal?

A timeless observation buried in Wall Street folklore, the quote has been attributed to Henry Poor, founder of the analyst firm Standard & Poor’s, and industrialist John D. Rockefeller, or perhaps financier J.P. Morgan. Per the web site www.quoteinvestigator.com the comment first appeared in a Wall Street Journal article, “What of the Market?,” October 18, 1922: “Henry Poor used to tell this story: He walked down to the financial district with John D. Rockefeller one morning and tried to elicit information as to the market for Standard Oils. The latter passed two blocks before giving an answer and then said slowly, ‘I think they will fluctuate.’” No matter who said it, that markets will fluctuate is the most accurate forecast anyone may offer.

Since investors had not experienced a true stock market correction in a little over three years, the gyrating trading week of October 13 unnerved some. A correction generally is defined as a decline of 10% or more from some previous high. Compared to the September highs, the Dow Jones Industrial Average (Dow) was down -5.2%; S&P 500, -6.2%; Nasdaq, -7.4%. How often does the market drop by 10% or more?

Capital Research and Management Company, studying market data from 1900 to December 2103, indicates declines of 10% or more average once a year. Declines of 5% or more, about three times a year. Twenty percent or more, every 3 ½ years!

Put that in perspective. On October 18, 1922, the Dow closed at 69.81. A 10% drop would be 6.91 points. On September 19, 2014, the Dow closed at 17279.74, an all-time high. A 10% drop would be 1727.97 points. Same percentage drop, but a bigger point number. Have our psyches adjusted to larger numbers?

Stock trading has changed dramatically now compared to “then.” In the early 1990s Vanguard introduced the first of a growing series of open-ended index funds aimed at individual investors. Prior to that if you wanted to own the Dow you had to buy 30 stocks, or 500 stocks to own companies included in the S&P 500 index. If you wanted to take your 30 stock portfolio to cash, you called your broker and sold 30 separate holdings, paying high commissions. With a mutual fund, you called the fund and you would exit at the net asset value of the shares at the end of the trading day.

Next came exchange-traded funds (ETFs), closed-end mutual funds designed to replicate indexes such as the Dow (DIA) and the S&P 500 index (SPY). Today there are hundreds of ETFs of the index variety as well as actively managed funds. Unlike their open-ended fund cousins, ETFs trade daily on an exchange like any stock. Traders can use margin and leverage against ETF holdings and sell short in speculative strategies as with any listed stock. Now, for Joe Public or Ginormous Hedge Fund, a quick buy or sell merely is a mouse click on a computer.

Adding to the ease of quick buying and selling at low commissions, “high-frequency trading” (HFT) was introduced after the collapse of Lehman Brothers to add liquidity to the markets. HFT programs employ complex algorithms to monitor multiple markets and execute orders based on market conditions. Some days, trading by computerized HFT “robots” can comprise an estimated 50% to 70% of volume, exacerbating market movements.

Investors must accept volatility as a given. If you are accumulating wealth, dollar-cost-averaging into the market, whether in mutual funds, retirement plans, or share-purchasing arrangements, can be your friend. Investing a constant dollar amount buys more cheap shares when markets are down compared to more expensive shares when prices are up. When market averages dip below 65 and 200 day moving averages, some investors take that as a signal to buy.

Retirees should have a strategy to deal with volatility, including reserves in safe money repositories and cash-flow-generating alternative investments to provide a “paycheck” or “playcheck” when you may not wish to sell stocks at lower levels. Even when prices dip, dividends are important to retirees. On October 18, 2014, the dividend yield on the Dow was 2.35%; 2.07% on the S&P 500. Compare that to the puny yields on money market funds and CDs.

Warren Buffett said, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” Fluctuations...expect them and sleep well regardless!

Lewis Walker is President of Walker Capital Management, LLC. Certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC. lewisw@theinvestmentcoach.com

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