We have probably all concluded that we didn’t learn anything from last week’s wild ride. Standard & Poor’s 500 Index closed 1% higher Friday and the DJI and Nasdaq 100 ended up recording their best week in almost two months. There will be many who believe that this was nothing more than a bout of market correction that is temporary, reversible and inconsequential.
The Dow, in fact, traveled 10,000 points in just five trading sessions .The VIX (Volatility Index) reached levels not seen since the 2008 global financial crisis.
Many people believe that the journey is less important than reaching their destination, so there is an inclination to think that last week’s volatility didn’t have much predictive value.
There are at least five reasons to prove that would be incorrect.
- The underpinnings of the financial markets are somewhat fragile.
- Many retail investors seem unable to deal with such bouts of volatility, thus you see disposals of equity mutual funds.
- Third, the plumbing of the marketplace appears far from immune to dysfunction during periods of great price volatility. The manifestations include elusive liquidity or trading systems that get overwhelmed when too many investors rush for the exit at the same time. The impact is amplified by the popularity of exchange-traded funds, some of which struggled to function as promised when subjected to market discontinuities and circuit breakers.
- During this volatility, the good gets thrown out with the bad. This is especially true with widely held investment brands—such as Apple, GE, and Google.
- Even though policy makers are eager to protect from this market volatility, they already have expended a lot of ammunition. As a result, the series of monetary policy actions in China and calming remarks the NY Fed President made last week could soon be tested by developments on the ground.
With all of this being said, more roller coaster rides could be in store. Two things investors should assess are: whether they can handle the volatility again without being force to sell at the worst possible time; and whether they have enough reserve funding to pick up the bargains that will most definitely become available.