Volatility Is Not Risk

The media and Wall Street have done a wonderful job of teaching their audiences that stock market volatility means risk.

Why?  

Well, if I need to sell you a new solution every week, then I have to create a monster that causes you to move around a lot – because every solution needs a problem to fix, right?

Meanwhile, the art and science of compounding gets interrupted when an investor responds by selling and going to cash out of concern for the future.

And the effect of the interruption's is made worse by that usual “fear trade” reaction, and thereafter, buying bonds.

Now think very clearly here - whether the trade "war" ends in an hour or a year - this is what is happening:

• Stocks are being priced down in panic to sell near 15 times earnings
• Bonds are being priced up in panic to sell near 47.4 times earnings, and
• The former will change in the future, while the latter won't (from an earnings perspective).

Seriously folks, do you honestly believe that you’re witnessing the end of a great economy right now?

Are we truly worse off than we were in December? Or March 2009? Or March 2002? Or 9/11? Or the "non-recession, recession" of 1994-95? How about October 1987?

The concerns will fade - making the next monster feel like "It's Never Been This Bad...."

The recent image below pretty much sums it all up:

Making sense of this mess in the media requires work to not be sucked in emotionally.  

Jeff Miller always does a great job of summarizing the week's events on his weekly Seeking Alpha notes at dashofinsight.com.    

In the chart below - Scott Grannis of The Calafia Beach Pundit shows us that the market is leading the US Federal Reserve towards its next steps, as the Generation Y deflationary forces we often note continue to increase:

The data above compare the current real Fed funds rate (blue line: the difference between the Fed's target funds rate and the year over year change in the PCE Core inflation rate) with the market's expectation of what that real rate will average over the next 5 years (red line: the real yield on 5-yr TIPS).

The message here is that the front end of the real yield curve is inverted, and that is a sure sign that monetary policy is likely a bit too tight.

Whereas the US Fed says it is likely to stand pat for the foreseeable future, the market is saying they need to cut the funds rate target to 2% (vs the current 2.5%) and hold it there for the foreseeable future.

Final Thoughts on the V-Word

We must learn to embrace the vast misunderstandings about the role that volatility plays in long-term portfolios.

Too much of it, and panic takes over; leading most to make disastrous decisions during the market’s roughest environments.

Not enough volatility and you’re probably not taking enough risk to earn the returns you’ll need for later.

Kind of odd right?  More volatility suggests a history of higher returns...

It’s counterintuitive to think about volatility as your portfolio’s best friend, but once you switch your mindset over to doing so, you’ll become a much stronger, far more patient - and better equipped investor.

This is a fact - no way around it: Risk and reward are inextricably linked.