BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Keep Calm Over Dow Jones Industrial Average's Nosedive And Carry On

This article is more than 9 years old.

Volatility on the markets is normal. Long live volatility! And, this week my thoughts returned to  turbulent stock markets around the globe. It does not seem so long ago that the equity markets on the major indexes were in rude form and hitting news highs. Then the wheels seemed to fall off the wagon in recent weeks with the Dow Jones Industrial Average (DJIA) and S&P 500 amongst other blue-chip benchmarks getting the jitters.

As recently as 23 July - just under three months ago - Jaco Rouw, Core FI Investment Manager at ING Investment Management, discussing how FX volatility was reaching new lows stated: “Going forward, there is always the possibility of shocks that will drive volatility higher. Apart from this, the current level of volatility seems justifiable and might stay at low levels in the near term.”

Indeed, at the time Rouw was commenting the JP Morgan index of three-month implied volatility across seven developed currencies traded below 5.2%, which was around half a point below the previous all-time low of 5.7% reached back in June 2007 (just prior to the US sub-prime crisis became a serious worry). In particular, the three-month implied volatility of the EUR/USD exchange rate touched a low of 4.77% - below 2007’s 5.00% level.

Fast forward to 14 October 2014 and Tom Elliott, International Investment Strategist at deVere Group, which has more than US$10 billion (bn) under management, spoke out against the backdrop of global markets remaining volatile due to a slump in oil prices, warnings that low prices might be here to stay and downgrading of global growth projections. His warning to institutions and investors was against “knee-jerk reactions” and he advised taking a “multi-asset” approach to spread risk. By the following day the VIX, the so-called ‘index of fear’ and a major gauge of investor concern hit an almost three-year high.

It also struck me that we have been here before in terms of fluctuating and rapidly declining equity markets. Most times the markets recover their poise. And, clearly if the experts knew all the answers they would probably have made their piles of cash, quit their day jobs and hit the beach for a long holiday. It only takes a major geo-political situation, terrorist attack or pandemic to arise and the Dow tanks in minutes. But nobody can predict these things.

Bear in mind too that swings of 100 points or more on the DJIA, the UK’s FTSE 100 or DAX in Germany are fairly common today. This volatility has been heightened in recent years through the rise of high frequency traders (HFT) and program trading on Wall Street, in London and on other leading markets.

It has been estimated that around 50% trading on the New York Stock is accounted for by computerised or rules-based trading through the use of algorithms. These trading systems suck in vast amounts of data, news and information before spitting out orders with great rapidity in microseconds and milliseconds.

One only has to see this in action when the US non-farm payroll number comes out on the first Friday of each month. A positive number - as with the latest one - has the effect of boosting the markets. A negative or less than anticipated one can cause the reverse. On the trading days preceding and immediately after the jobs number came out the Dow was in negative territory by a three-digit points figure. In the not so distant past falls of 30 or 60 points would make front-page news.

In terms of some recent action, the DJIA lost as much as 460 points (c.2.81%) in afternoon trading on 15 October 2014 before clawing back ground it had lost to close at 16,141.74 - a drop of -1.06% on the day. Yet put in perspective over the past 12 months the index is trading 7.024% lower than the 52-week high (17,350.60) and 5.93% higher than the 52-week low of 15,229.00. The closing index level as of 15 October puts the index at where it was back in mid April this year.

So, given that it has not lost 10% from this year’s peak, which would require the index to drop further by around 500 points - one could argue that the correction is just that - a correction. And, it was probably a tad overdue. Indeed, so far in 2014 the Dow had - until giving up recent ground this October - risen by 645.28 points (c.4%) between 2 January and 23 July 2014.

Go back almost two years to 3 January 2013 when the index was at 13,391.36 points - the rise to date has been 20.54% (2,750.38 points), while almost five years ago (2 January 2010) it was at 10,618.19 points. And, despite up and downs along the way the overall trajectory since then has been steadily upwards. My feeling is that the index had been racing away too fast until the latest correction, and we would have to see significant further declines towards 14,000-15,000 territory before really panicking.

Wall Street sign on Wall Street (Photo credit: Wikipedia)

Turning our attention to the thirty components comprising the Dow shows variance in the percentage falls since the respective recent peaks this year. American Express, for example, which closed at US$80.93 a share on 15 October 2014 had lost US$15.31 or 15.9% since 3 July 2014. Boeing shares meanwhile have shed US$24.28 (16.81%) from their year peak; Chevron Corporation US$25.83 (-19.1%) lower than on 24 July; Cisco Systems 8.85% lower than on 16 July; JP Morgan Chase US$5.41 (8.875%) lower than 23 September; and, Goldman Sachs Group Inc. down US$10.83 (-5.75%).

Therefore not all the components had tanked as one might think by a simple an end-of-reading of Dow. And, critically it all depends on when investors bought and timed their share purchases in the first place. Take a stock like Goldmans. Had one bought into the US investment bank on 26 December 2011 the price would have been around the US$90 mark - almost half of what it trades at today. Similarly, Visa Inc., which closed at $200.25 each on 15 October 2014 (US$35.25 (14.9%) off its year high), could have been snapped up at around US$155 a pop on 2 January 2013.

Who knows where will be next week, next month or even next year in terms of the Dow’s level. What this volatility does highlight though is that it can help if investors diversify their portfolios outside of just stocks (equities) into safer havens, metals like gold and silver, property through real estate investment trusts (REITs) and exchange traded funds (ETFs), the latter effectively a share that replicates an index and tracks it.  They should also consider stocks that have good dividend and yields as well quality plays. They are out there if one looks.

At the end of the day while there is a lot fancy talk around investing and how to do it, fundamentally it revolves around three basic things: what to buy, when to buy and when to sell. Some investors will see the latest level on the Dow as a good buying opportunity to top up their existing holdings. But caveat emptor.