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Fearing a massive market turndown? Why it’s ‟way too early” to be concerned

In China, ‟retail investors are quite emotional, get frightened very quickly,” Eric Kirzner says

“This level of volatility might continue for some time to come,” Professor Kirzner says (photo by James G via flickr)

For investors, it’s been a nerve-wracking week. The Toronto Stock Exchange and Dow Jones Industrial have dropped dramatically. China has shut down trading twice and sliding oil prices have triggered fears of global economic instability. 

U of T News asked Professor Eric Kirzner, a finance expert and the Rotman School of Management’s John H. Watson Chair in Value Investing for insight on what’s driving stock prices down and what individual investors need to do. 

What’s causing the stock market to nosedive?
It’s still a little early. We’ve seen a lot worse of course, but there are a numbers of factors going on right now. The obvious one is China but that’s not the only issue here. Markets were supported for many years by falling interest rates, and interest rates have hardly anywhere to go but up. So of course there’s concern about rising interest rates and the effect that will have on the markets. 

I think that concern has been overblown because, of course, interest rates are way too low. It’s not healthy. There are still geo-political concerns. We were talking about the so-called PIIGS countries last year −Portugal, Ireland, Italy, Greece and Spain. That has died down for now but it hasn’t gone away. 

There are still concerns about debt levels in certain countries. But ultimately what is going to drive markets is not geopolitical. It is earnings and interest rates. So it’s way too early to be concerned about some massive market turndown at this stage. It’s probably the worst start to the market that I can remember since 2008. Last year was not a great year for markets, and we’re off to a poor start this year. But nevertheless it’s way too early. ”

What’s been China’s role in the stocks declining?
China’s growth levels have been way lower than expected. But the China market is quite different from North American and European markets. The China market has always had a very high domestic investor participation rate. It seems that retail investors are quite emotional, get frightened very quickly. They get very impatient. You have a market that is dominated by the retail sector. Pricing gets carried away from time to time. The idea of introducing circuit breakers probably was a mistake. 

But I would point to the nature of the China market, and the fact that it is by nature very volatile and the very high retail participation in that market. So what you have is these periodic short-term panics that occur in China. We’ve seen three or four of them over the past few years. It’s happened twice this week. 

The China growth story is not over. Its growth is weaker than it has been in the past, but China is still a powerhouse.  

What will restore the market?
Ultimately, the markets will recover if we start to see solid earnings from major companies, interest rates stabilize, and there’s a coherent policy globally in terms of interest rate increases. They’re not going to be frequent and sudden. But they’re going to be gradual. If China stabilizes, I could very well see the markets start to recover.

So what should investors do?
There are two types of investors. There are always buy-and-hold investors, which is what I’ve always recommended. These are investors who build a portfolio. They tend to hold it, and make very few changes, and they adjust the portfolio with their change in lifestyle but not with the basis of changing economic conditions. 

For those investors, the right thing is to get their asset allocation correct. They need to have the right mix of safety, income and growth. If they’ve found the last few days too frightening, then maybe they’ve got too high an equity exposure. I was just talking to an investor the other day who is quite sophisticated and I said, “What have you been doing the last few days?” He said, “Eric, I learned this from you. I just ignore what’s going on. I’ll check out my wealth level in a month or two, but I am not going to be making any changes on the fly.” 

Then there are the momentum or trader type investors who have to outcast which way the markets are going. That’s a very, very tough call at a time like this. Where the markets are going to go in the near term, I don’t know.  This level of volatility might continue for some time to come. So investors with active trading dispositions, you’re going to find a very, very tough market. 

But what choices do investors have? Cash-earnings, putting the money in bonds, preferred shares? These have been disappointing for investors. So really, stocks have the most promise at a time like this. That shouldn’t mean you should overload your portfolio in stocks because you have to have the right mix. But investing has been very tough for the last few years because interest rates have been so low. You have to have the stomach for it. You have to have the ability not to read everything that’s happening, the ability to be patient and see through the short term volatility. At the same time, you have to have an appropriate mix that doesn’t leave you openly vulnerable to the market either.

(visit flickr to see the original of the photo used at top)