(MA) Be Calmer Than Mr. Market – AAII Investor Update

The market can be finicky over the short term.

This has particularly been the case over the past few days, with stock prices fluctuating widely. Some stocks have been excessively volatile. Take Mastercard (MA), for instance. Shares of MA fell 10.6% on Monday, rebounded 10.6% on Tuesday and fell 5.9% on Wednesday. The stock gained 7.7% yesterday. One does not have to be an expert on Mastercard to assume that its business does not change that much on a daily, or even weekly, basis.

In his classic book, “The Intelligent Investor,” Benjamin Graham described Mr. Market as a business partner who “lets his enthusiasm or his fears run away with him.” The description certainly applies to the erratic price movements we are currently seeing. Over short periods of time, the markets do not act in a rational manner.

This is not to say that everything is fine or to ignore some of the recent headlines. Economic growth has been slower than economists expected and could remain sluggish for the foreseeable future. The risks of a recession have increased. Standard & Poor’s downgraded the United States’ credit rating. People are worried about the economy, the stock market and now, French banks.

Yet most of this is not surprising. There have been several economic reports that pointed to sluggish growth. The U.S. debt exceeds $14 trillion, and our elected officials in Washington have yet to agree on a long-term solution, whether it is based on Simpson-Bowles or an alternative. Predictions of when the Federal Reserve will raise interest rates have proved to be premature, as Tuesday’s Fed statement made even clearer.

If the markets were truly efficient over the short term, prices would reflect not only these facts, but also the realities that the U.S. economy is still growing and large-cap stocks are cheap relative to trailing and forecast four-quarter earnings. Rather, we are seeing volatile conditions caused by a combination of headline risk, investor emotion and rapid-fire electronic trading systems. It’s not fun, but this volatility is why stocks deliver high long-tem returns. The annualized 9.9% long-term gain for large-cap stocks is Mr. Market’s way of saying “I’m sorry for driving you crazy.”

So what do you do with Mr. Market? The temptation is to love him when stock prices are rising and leave him when stock prices are falling. The problem is that his mood can change quickly and he rarely announces that he has gone from being glum to chipper. So, you have to either correctly guess what his mood will be from day to day (a very difficult task) or invest for the long term and ride out his temper tantrums.

Either way, you should use down markets to look for bargains. Fear, as uncomfortable as it is, causes stocks to be mispriced. Even if you think stock prices can fall further, you should at least create a list of stocks that either look attractive or would be attractive if their prices fell further.

I have yet to see a correction where people didn’t fear a catastrophe, or a rebound where people didn’t wish they had bought during the correction. I don’t think this time will be any different.

Consider a Roth IRA Conversion

Now is not a bad time to consider a Roth IRA conversion, if you can afford to pay the taxes. The decline in stock prices has reduced the value of any equity-related investments you hold in a tax-deferred account, such as a traditional IRA. This means, relative to this summer, you will have a lower tax bill for converting or can to move more shares over to a Roth IRA for the same amount of taxes.

A conversion occurs when you move assets from a tax-deferred account to a Roth IRA. Since a Roth IRA is funded with post-tax dollars, you will have to pay taxes on any assets that are converted. The advantages are that future withdrawals will be tax-free (subject to certain limitations) and there are no required minimum distributions (RMDs). Thus, the decision on whether to convert or not depends on your ability to pay for the conversion, the projected tax savings and your long-term financial plans.

This Week’s Gratis Tip

Any time a market correction occurs, the focus of many investors invariably turns to how risky stocks are. Risk is about more than just how volatile the market is; it is also about how fluctuations in your portfolio’s value impact your financial goals.

While you may feel risk tolerance depends on how you emotionally react to bad news about the market, your time horizon, wealth and investment knowledge also play a role. For Long-Term Investors, the Focus Should Be on Risk explains why and gives suggestions on how risk tolerance affects your portfolio’s allocation.

The Week Ahead

Approximately 25 members of the S&P 500 will report quarterly results next week, as profit season shifts to the retailers. Dow components Home Depot (HD) and Wal-Mart (WMT) will both report on Tuesday. Joining them will be Lowe’s (LOW) on Monday and Target (TGT) on Wednesday.

A third Dow component will also report earnings: Hewlett-Packard (HPQ) on Thursday.

The week’s first economic reports will be the August Empire State manufacturing survey and the August National Association of Home Builders’ (NAHB) housing index on Monday. Tuesday will feature July housing starts and building permits, July industrial production and capacity utilization, and July import and export prices. The July Producer Price Index (PPI) will be published on Wednesday. Thursday will feature the July Consumer Price Index (CPI), July existing home sales, the August Philadelphia Federal Reserve manufacturing survey and the Conference Board’s July leading indicators index.

Cleveland Federal Reserve President Sandra Pianalto will speak publicly on Friday.

August stock options will expire on Friday.

Charles Rotblut, CFA is a Vice President with AAII and editor of the AAII Journal.

View original at: AAII Investor Update E-Newsletter

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