Amidst this very dark outlook for Europe, markets oscillate daily. Big rallies follow big sell-offs. Hope follows fear as faith in the ‘bailout’, the ‘rescue’ and the ‘stimulus package’ trumps all other logic.
That’s where you are today. Hope and fear are the two dominant market characteristics. They are also the enemy of the rational investor. So try to put the large daily moves into perspective. It’s what happens when risk and uncertainty are on the rise.
A good illustration of this is the VIX indicator – commonly referred to as the fear gauge. The VIX is a measure of volatility. A spike in the VIX correlates to a drop in equity markets. The chart below shows the VIX over the past 5 years.
Back in 2007 and early 2008, the VIX indicator displayed increased volatility and traded at a relatively high level, before blasting higher as the 2008 credit crisis hit. It then spiked to an index level of just over 45 in 2010 and 2011. This was in response to the end of the US Fed’s monetary stimulus measures.
As you can see, the recent increase in the VIX is not as severe as past spikes, suggesting market-wide ‘fear’ is still in its formative stages. Given Spanish and Italian bond yields are well over 6% (suggesting the market’s concern over their debt-dynamics) it appears investor faith in policymakers is alive and well.
The VIX – Not Very Scared…Yet
To me, that remains a dangerous sign. It points to a mentality of ‘bad news is good news’. In other words, bad news on the economic front means good news on the government stimulus front. That doesn’t sound like a very good investment strategy to me. In fact, putting your faith (and your wealth) in the hands of those that ultimately destroy it seems like lunacy.
But such has the investment landscape become. We constantly need to weigh up the economic with the political/policymaking landscape.
Economics – which is simply a reflection of human action and the laws of nature – will trump policymaking every day of the week. But it will do so slowly and imperceptibly. Look at what’s happening in Europe now…as the true nature of debt overwhelms governments, investors still cling to the hope that policymakers can do something.
They can’t…they are simply pawns in the game masquerading as kings.
The Aim of Investing
With this continuing all-pervading noise dominating markets, it’s important to refocus on what the whole point of investing is about. It’s to compound your wealth.
That’s a very difficult thing to do in a bear market. In fact, in a bear market you’ll find it very difficult to compound your wealth at all. That’s why a bear market should be all about wealth preservation. The bull will inevitably follow the bear. Years of 5%, 0% or -20% returns will fade away, replaced by consistent 10-20% returns.
That’s when you make your money. Wealth preservation is the most important thing to think about in this market. If you can survive the bear and get to the start of the next bull with your wealth intact you will be miles ahead of most other investors.
Think about it.
Bear markets wear investors down psychologically. People spend years moving money around, trying to find a winner. The market chips away at their capital year after year. It’s only after the majority of investors feel the greatest amount of pain and get out of the market – for good – that a new bull market gets underway.
That’s what I want you to think about amongst all this gibberish about bailouts and government stimulus. You’re here for the long haul. You’re here to outlast the bear and be ready for the bull.
Waiting For The Bull
Government meddling will only make the bear worse, so the arrival date of the next bull market is anyone’s guess. Lower share prices are a good sign, as it will indicate a loss of government control of markets.
However, governments don’t like to lose control. Printing money will allow them to maintain the fa鏰de that they are in control. That being the case, I think the next step will be to think about at what point government printing tips the bond market over and forces a rush of capital from bonds into equities.
My guess is that point is still a year or two away. Asset price deflation awaits us first. But it’s worth starting to think about a shift in sentiment (and capital) well before that happens.
For now, the key is to continue with the wealth preservation and compounding theme. A bear market won’t reward compounding very much, but your patience should pay off in a big way when the bull returns.
Greg Canavan
Editor, Sound Money. Sound Investments.
From the Archives…
The Problem With the Spanish Bailout
2012-06-15 – Keith Fitz-Gerald
Australian Housing – How to Avoid This Pauper’s Retirement Trap
2012-06-14 – Kris Sayce
Why Warren Buffett is Loading Up on Tungsten
2012-06-13 – Don Miller
China’s Economic Data Statistics: Just Add Salt
2012-06-12 – Dr. Alex Cowie
Why Graphite is One of the Few Places For Savvy Investors to Make Money
2012-06-11 – Dr. Alex Cowie
