The market can be a rollercoaster ride |

The market can be a rollercoaster ride

Richard Loth

I’m often asked by clients and participants in my investment classes why stock market prices go up and down. My answer, which is not meant to be flippant, is “because they do.”Price volatility, to one degree or another, is a characteristic of the securities markets. This volatility comes in several varieties. In its mild forms, volatility is the friend of experienced, long-term investors. When quality issues drop in value, these patient investors can buy more of a good thing at what they perceive to be undervalued prices. However, it’s difficult for the general investing public to be sanguine about price volatility. Unexpected, sharp price movements downward are alarming, while upward movements are met with shouts of glee. Such are the emotions of investors on both Wall Street and Main Street.Some perspectiveOn those occasions when the media bombards us with alarming headlines and television interviews related to some huge sell-off in the market with significant price declines, remember this simple investment truism – for every terrified seller, there’s a confident buyer. One investor’s pain is another’s pleasure. Also, the average trading volume on the New York Stock Exchange is about 1.5 billion shares a day. Let’s say that this volume jumps up to 2 billion shares on a really scary day with a big drop in prices. According to the NYSE’s research statistics, the total number of shares outstanding for its listed companies is 368 trillion. Thus, two billion shares represent less than one percent of this total, i.e., 99 percent of the shares didn’t even trade. Focus on fundamentalsIndividual investors need to stay focused on four market fundamentals: The direction of the economy as measured by the movement in the gross domestic product is a key indicator. Last year we had GDP growth above 4 percent, which is excellent for an economy of this size. This year, it looks like we’ll still have growth, but at a lesser rate of 3.5 percent, which is still pretty good.Interest rates and inflation also play key roles in influencing investment performance. In both cases, 2005 doesn’t look too bad. Yes, interest rates are expected to continue their climb, but will do so at a moderate pace. And inflationary pressures are expected to level off. Lastly, the performance of corporate earnings needs to be watched closely. In recent years, we’ve enjoyed high, double-digit year-over-year earnings increases. While a moderating trend is currently evident, the consensus growth forecast for corporate profits in 2005 is still up in the high single digits. That’s not over-the-top but still not bad, and in keeping with the moderate trends in interest rates and inflation.Short-term demonsYour ability to keep your eye on market fundamentals, as well as those of specific companies and funds, will be sorely tested by the activities of hedge funds, program traders, and performance-driven institutional investors. Because of these players, market volatility has increased sharply over the past decade.BusinessWeek Online’s Amy Stone described the “ruthlessness and randomness” of this crowd: “The trading is fast, short-term … often highly leveraged … and likely to be driven by cues from a computer or technical chart.” This focus on quick, immediate gains can create “sudden, sharp intra-day spikes or sell-offs” that have little to do with investment fundamentals, Stone said. This frenetic, opportunistic trading, while entirely legitimate, is not investing – it’s pure speculation. Individual investors need to recognize this disruptive phenomenon for what it is and stick to doing their investment homework and keeping a patient, long-term perspective.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing. He is an independent registered investment adviser and can be reached at (970) 827-5591 or Colorado

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