Risky Business

After a pretty robust recovery in 2009 and 2010, the stock market took a dive in the last two months.  The talk of a “double-dip recession” is reaching a fever pitch.  A search of the term “double-dip recession” at Google News generates over 7,000 news articles.  Media pundits point to the recent market downturn as evidence of a new recession.  High unemployment, Europe’s debt crisis, a slowdown in China, a teetering housing market and sinking stock prices are all weighing on a fragile U.S. recovery.  The news is filled with grim stories and dire predictions.  Again.

To be sure, the uncertainty about the domestic and global economy is priced into current stock market valuations.  It’s important to remember that stock market prices do not fall in a vacuum.  For every sale of a security there is a willing buyer on the other side who thinks the security has great growth potential.  The interactions between buyers and sellers are what make financial markets efficient.

I don’t know if the economy is headed for another recession; however, there are some economists who see light at the end of the tunnel.  In its biannual report on the global economy, released in May 2010, the international Organization for Economic Co-operation and Development (“OECD”) said the economy is recovering faster than expected.*  The OECD lifted it’s projections for global economic growth to 4.6% in 2010 and 4.5% in 2011.  The OECD did caution about risks including overheating emerging markets and international debt crisis; however, the overall message was one of cautious optimism.

Additionally, the U.S. and other developed countries are introducing legislation to improve transparency in financial markets with an eye on reducing systemic risks in the current system.  That’s a fancy way of saying these excesses have a way of working themselves out.  Once investor confidence increases, markets should be poised to rebound.

As investors we understand the risks of investing in the stock market.  We may not like the volatility and uncertainty, but we expect to be compensated for the risk we are taking.  And we take this risk for a very good reason:  to accumulate enough money to maintain our purchasing power when we quit getting a paycheck.  A well thought-out investment strategy may not have great outcomes in the short run, but maintaining discipline in down markets will lead to long-term investment success.

You can’t change your feelings about what’s going on in the world.  You can only change your actions.  For younger investors in the accumulation stage, you are in a great position to benefit from the market declines.  Keep contributing to your investment accounts and buy “low.”  It’s actually a great time to increase your regular investments if your budget allows it.  For retirees who rely on their portfolio for income, there are fewer options.  The most obvious is to scale back and lower expenses during periods of uncertainty.  If your withdrawal rate is low enough (3%-4% of your portfolio), then you should be confident that you have time for your portfolio to recover.

Be prudent and conscious of what is going on, but don’t let the news distract you from living your life.  Having trust in your investment plan will allow you to ignore the noise in the financial markets and focus on long-term success.
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*OECD Economic Outlook, May 2010