Over the past several months, I’ve talked a lot about volatility and how it reflects the uncertainty about the future.  The sovereign debt issues in Europe and the U.S. have led to fears of another recession.  As a result, market participants are applying higher discounts to risky assets, which is another way of saying that they require a higher return in light of the uncertainty.

Recent economic data have helped ease concerns of the U.S. economy sliding back into a recession, but the labor market is still struggling and the crisis in Europe will continue to pressure markets until policy makers come up with a durable solution. Nobody can predict what will happen next, but I’ve put together a few thoughts that might make the up-and-down markets a tad more tolerable.

Don’t make presumptions.

Markets are unpredictable and don’t always react the way you might expect.  For example, the U.S. bonds rallied after being downgraded by Standard & Poor’s.  Another example is that markets have historically performed well following periods of low confidence.  According to Liz Sonders (Chief Investment Strategist at Charles Schwab) the average gain for the Dow when confidence has been below 66 (as it is now) has been 12.5% annualized.

Someone is buying.

The financial media is in the business of turning investing into entertainment, so they tend to highlight fear in with headlines like, “Investors Are Dumping Stocks.”  But remember, someone is on the other end of every trade, and it is usually long-term investors buying these unloved assets in uncertain times.

Market timing is hard.

Remember, the stock market is a leading indicator and many economic indicators reflect what’s already happened in the economy.  Recoveries come unannounced and are often just as swift and dramatic as the prior correction.  Don’t make the mistake of realizing the downside of stocks by turning paper losses into real ones without waiting around for the upside.

Higher return comes with higher risk.

Stocks offer higher expected returns than bonds, but with this premium comes higher risk, which is manifested in short-term volatility.  In order to capture the higher returns of stocks, investors must accept the possibility of experiencing daily, monthly, and yearly losses along the way.

Nothing lasts forever.

A common investing mistake is to project recent outcomes into the future.  When stocks are rising, we tend to buy because we feel comfortable and confident the gains will continue.  Similarly, when markets experience a downturn, fear sets in and we are often quick to sell.

Diversification and discipline are rewarded.

The ups and downs of your portfolio can be smoothed out by spreading the risk around.  Investing in a mix of stocks, bonds, and cash investments (and diversifying the investments within each of these asset classes) is crucial to investing success.  Sticking to this allocation also requires a level of discipline that is difficult to maintain, which is why most people benefit from having a financial advisor.

Thanks for reading,

Peter Lazaroff

St. Louis, MO

www.acrinv.com