Stay Focused on the Big Picture

Legend has it that one day a nervous Henry Poor, the origin of the “P” in the S&P 500 stock index, asked J.D. Rockefeller where a very volatile stock market might be headed. Rockefeller responded, “I believe the market will fluctuate.” This tongue in cheek response is a reminder that our eagerness to project future market trends is inversely related to our capacity to do so. The obligatory disclosure here is that projecting market trends is a difficult task at best, and there is obviously no guarantee that any projection comes to pass.With that said, when the economy is running smoothly, and markets are trending up there is generally little interest in market projections. On the other hand, when the economic outlook is shaky and market volatility surges, investors are eager to hear analysts' market projections. Unfortunately, high levels of economic uncertainty, such as those that triggered this year's market downturn, imply lower accuracy of any market projections. High uncertainty by definition leads to lower accuracy.

The good news is that long-term investors don't need high levels of accuracy to implement a reasonable investment strategy. They should stay focused on the “big picture” trend. Knowing if things look good or bad is good enough to determine if their equity exposure needs to be adjusted. The bad news is that a lot of recent market volatility appears driven in part by a huge increase in investors' appetite for market analysis reports. Analysts have responded by cranking out a large volume of reports which often contain unrealistically specific projections given today's uncertainties. When the actual economic data is subsequently released, markets have often had out-sized reactions to small deviations between the projected and the actual results. For example, the August consumer price index increased 0.1% vs. a projected decline of 0.1%. The Dow Jones Industrial Average dropped over 3.5% in response.

Inflation has been with us for over a year, so what does it say when the markets have such a large response to such a small error in projections on just one month of inflation data? Investors are either extremely short sighted, extremely nervous, or both. Long-term investors should ignore month to month noise and focus on what the Federal Reserve is telling us. The Fed's interest rate policy is the big picture key to our economic future. In late August, the Chairman of the Federal Reserve finally admitted its policies will “ bring some pain to households and businesses.” That's a major shift from prior talk of an economic soft landing. From a big picture perspective, that's all we need to know.

One parting thought. Short-term interest rates were over 5% before the financial crisis of 2008. Today's rates are only 2.5%, so based on recent history there is plenty of room for more rate hikes. I expect rates to hit 4%-5% and stay there for at least a year. A buying opportunity may be at hand once investors come to grips with that reality.

Frank Rizzo, CERTIFIED FINANCIAL PLANNER ^TM

The opinions in this material are for general information only and not intended to provide specific advice or recommendations for any individual. The economics and market forecasts set forth in this material may or may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing includes risk, including fluctuating prices and loss of principal. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.