1. Most days recently have become an “all or nothing” with the stock market, with stocks surging to the best results of the year one day, while falling to new multi-year lows the next. What are the factors contributing to the extreme volatility in the market of late?
There are many factors with the recent wave of volatility in stock prices and the market. Among the major contributors to this surge and retreat behavior is: fear that the economic recovery we have enjoyed for the past seven years is ending, the devaluation of the Chinese currency and the overall state of the Chinese economy as it affects the global economy and the price of U.S. stocks. Prices of U.S. stocks should reflect future earning potential; if the future is not bright economically then future profits will not materialize and thus stocks are not worth a higher price.
2. How does this extreme volatility affect publicly traded companies in the U.S., especially those making initial public offerings in 2015?
Volatility is equated to risk when investing in stocks. Think of risk in terms of not meeting expected return requirements. Return relies on the purchase price of the stock, the amount of the dividend (if any) and then the price we sell the stock at after a certain amount of time or duration. If prices are swinging wildly we have little confidence that we are paying an appropriate price to allow us an appropriate return over a certain time period.
Initial Public Offerings are very sensitive to this volatility because the market may over-price the new security to the point that it will need to be held for an unreasonable amount of time to have the profits generated by the company that are enough to justify the price for the stocks. In that case, people will sell the stock at a loss and the company reputation as a solid investment may never recover.
3. How should investors approach the recent volatile market? Are there safe ways to invest during a volatile period, or ways investors can take advantage of these large swings?
The term safe and taking advantage of volatility cannot be used in the same sentence (smile). We sometimes use the analogy of “catching a falling knife” when we try to time the market for a price that has dropped significantly. Just because the price has fallen does not necessarily mean it will go back up. And even if it does go back up a bit, it will still fall if the stock is not worth the price.
One thing that is safe during a period of volatility is to keep a straight head. Do not react just because prices are fluctuating; if you own a company that you know is solid and, in particular, one that pays a good dividend, just hold onto the stock and ride out the wave. If you are investing for the long term and do not need the money then research has shown that people who do not try and time the market end up in a better place than those who do try and play the wave.
4. What is the impact on foreign markets when our stock market is experiencing such volatility? In turn, how can foreign markets affect our stocks here in the U.S.?
The world is an interdependent economy and stock markets are a reflection of economic activity. As economic leaders in the world and the world’s single largest economy, we obviously impact all other economies and markets. However, foreign markets such as the European Union and China are catching up to our economy, and they are indicators of worldwide economic health.
Our trading partners impact the profits of our corporations and if economies are slowing then activity will slow and profits will fall. As profits fall, markets fall and stock process fall. When the net worth of households falls, then consumer confidence falls and they stop buying things. It is a self-reinforcing cycle.
5. How does this extreme volatility in the stock market reach an ending point and return to average trading?
We will not return to normal stock market activity until there is stability in the economy and in the rate that companies’ earnings rise. When we all can say that the government can stop meddling in the economy, when companies are hiring and when consumers are spending, then we should be able to say, with some kind of confidence, this price is good for the risk I am taking when investing in this company.
Stephen Paulone, Ph.D. is the Director of Graduate Business Programs offered through the Malcolm Baldrige School of Business at Post University. He has more than 25 years of experience in manufacturing, marketing, and finance, and has held such positions as marketing manager, manager of new product development, marketing program manager and finance director.