Forget trying to build the tallest or fastest roller coaster in the world; if you want a real thrill, just be an investor in the stock market over the past two weeks.
Following a nearly 1,900-point swing lower in the Dow Jones Industrial Average in a span of just six trading days, the Dow wound up recouping practically 1,000 points in the subsequent three-day span. It’s been the most volatility and fear investors have witnessed since the Great Recession, and as you might have guessed, it has investors on edge.
Five reasons the stock market could head lower
Truth be told, there are always reasons to be skeptical of growth in the U.S. economy or the stock market, but those fears don’t always manifest in the type of selling we saw in August. However, our quick snapback offers no guarantees that we’ll continue to rebound from our recent lows.
With that in mind, let’s briefly look at a handful of reasons why the stock market could head even lower and also look closely at why a move lower really shouldn’t matter.
1. Investors are highly emotional
One reason I’d suggest the stock market could move lower is investor sentiment. While long-term investors are generally disciplined in regards to keeping their emotions out of the investments, there are quite a few traders that aren’t focused on the long term. Traders, active Wall Street firms, and hedge funds can very easily cause the stock market to overshoot up or down on the slightest hint of good or bad news because they allow their emotions to drive their investing, rather than focusing on the bread-and-butter fundamentals and long-term thesis that would drive a company higher or lower.
2. Oil fundamentals offer little near-term relief
It’s impossible to tell whether a rapid rise in oil prices led last week’s rally or if the rally led oil prices higher, but the point remains that oil’s (West Texas Intermediate and Brent) fundamentals remain under pressure.
For example, within the United States the oil rig count has more than halved over the past year from a peak of 1,609 to 675 as of last week. Despite this, production per rig has more than doubled, meaning despite fewer rigs we’re seeing production remain steady from the year-ago period. This isn’t helping to solve the major problem with oil, which is oversupply. If there are fears of a recession or slowdown in the U.S., China, or other developed parts of the world, this oversupply worry could further pressure the stock market.
3. Federal Reserve indecisiveness
Another concern that could rear its head and push the markets lower is indecisiveness from the Federal Open Market Committee. To be clear, there is no magic formula that determines when it’s right time or wrong time to raise or lower the federal funds target rate (which will ultimately affect the interest rates that you and I pay for our mortgages, credit cards, loans, and so on). However, with the federal funds target hovering near 0% for better than six years, skeptics abound who are worried that low lending rates could lead to a rise in inflation or perhaps another bubble in the housing market. Long story short, the more befuddled the FOMC looks, the more pressure we may see put on the stock market.
4. Foreign jitters
It’s quite possible we could see China or Greece weigh on the market as well. China’s annual GDP growth, while still well above the global average, has been below its three-decade historic average of 10%. Recent manufacturing data from China looked grim at 47.8 (a two-year low, that implies contraction) , and there are concerns among investors that the Chinese government may not have the tools necessary to jump-start its economy back to its previous growth levels.
As it pertains to Greece, the concern is that the highly embattled Euro nation could renege on its bailout agreement or put up a fight against stipulations for its bailout. While Greece getting additional money from its lenders is a step in the right direction, it merely sweeps Greece’s many problems under the rug, and it could continue to drag down growth prospects throughout the EU.
5. The “X factor”
Lastly, we have the “X factor.” The X factor represents one of an infinite number of problems that could develop that investors simply don’t see coming. A vast majority of our corrections and/or bear markets over the past couple of decades have occurred from issues out of left field that few investors saw coming. Thus, who’s to say that an under-the-radar concern won’t pop up and push the stock market lower once again?
Why a market move lower shouldn’t worry you
There may be a laundry list of reasons why stocks could see additional downside from the August correction, but that’s not necessarily bad news if you’re a long-term investor.
In the stock market, there are no givens. But the closest thing to a given I can point to is that stock indexes (at some point) move higher from the peak of a previous correction or recession 100% of the time. I personally don’t have the patience to count every correction or bear market in recorded history, but I can tell you for a fact that all 33 corrections/bear markets since 1950 in the S&P 500 have been put well in the rearview mirror. In fact, between 1975 and 2000, it took two years or less to recover the loss witnessed in all 12 corrections/bear markets. For risk-averse long-term investors, it simply means that buying an index fund, such as the SPDR S&P 500 ETF, should net you a positive gain over the long run if this aforementioned trend continues to hold true.
Stock market corrections are also an inevitable function of fluctuations in the U.S. economy, and your opportunity to pick up high-quality stocks at a cheaper price point than in recent months or years. Unless a company’s business model has changed, then a simple correction in the stock market probably isn’t going to have much of a long-term effect on the bottom-line profitability of a high-quality company.
Lastly, it’s important to remember that stocks still give investors their best chance to build real wealth over the long run. Sure, CDs, money market accounts, and bonds might be a less volatile bet, but compared to inflation, they’ve been moneylosers over the past couple of years. With the stock market returning an average of 8% per year, historically it gives investors a genuine opportunity to grow their wealth.
As Warren Buffett once said, “Be fearful when others are greedy, and greedy when others are fearful.” Perhaps it’s time to take those words to heart.
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