Monday, October 15, 2018

A Pin for a 9-year Bubble?

Government and Your Money

I'm no fan of big government, but people often wonder: can the federal government's actions really affect my money?

Yes, it can. But probably not the way you think it does.


For those keeping score, I started writing this on October 7, 2018, several days before the roughly 800-point Dow Jones drop on October 10. This advice transcends the moment. But if you don't believe me, read
this.

The most direct way the government can affect your investments? By impacting market sentiment.

The Federal Reserve can change interest rates based on economic indicators, which tells investors how the federal government thinks the economy is doing.
  • For example, a lower "prime rate" means that it's cheaper to borrow money. This means that the government thinks that the economy needs a jump start (by making it cheaper to borrow money to buy a house or car, or to start a business and hire employees).
     
  • By contrast, raising the prime rate means that the economy is recovering from a slump, so the aforementioned "jump start" is no longer needed.
But another way is through the declarations of key elected officials, particularly the U.S. President. To use a current example, Donald Trump's election was seen as a boon by many in the business world, especially those in the finance and real estate industries.

This elation about having a "business-friendly" President can—and does—lead to more optimism about how the market will perform, which can lead institutions (like big investment banks) and individuals (like venture capitalists) to sink more money into the markets.

And, as we all learned in economics 101, what happens when the demand for a product/service increases?

Of course, greater demand leads to higher prices.

And, in the case of the stock market, that means that exuberance over the President's policies—whether those policies are really enacted with legislation, or simple announcements with no current action backing them—can artificially prop up the stock market for a period of time.

But, as Warren Buffett aptly noted, "A pin lies in wait for every bubble." That is, the market won't stay inflated forever, because people won't stay optimistic forever.

So am I arguing in favor of Trump? Or against him?

Neither. Remember to take the long view—in the long run, there's only a limited amount of impact any given person can have. Even a U.S. President!

What I'm saying here is that I believe that Trump's election in November 2016 has delayed the stock market correction that I've been expecting for a while. A several-hundred point correction just recently hit, and I'm not sure that it's done yet.

History shows us that a 9-year-long high-performing 'bull market' is nearly unprecedented. That indicates that it's only a matter of time before the market drops by 10 or 20 percent, regardless of what anyone tries to do to stop it.

Occasional corrections are part of the functioning of a healthy market, just as excursions to the bathroom are necessary in order for your body to continue to work normally. In both cases, the experience may not be pleasant, but it's both necessary and inevitable.

So make use of your knowledge. Whether you support the current Presidential administration, oppose it, or ignore politics completely, you can become wealthier by paying attention to the current situation and preparing yourself for a market correction.

When people start to panic—that's a good indicator that the market is close to the bottom. And when you get uncomfortable with how much/how long the market has been dropping, that's a good sign that you should swallow your fear and buy more shares of a low-cost index fund, because the rebound is imminent.

You may not feel great about buying into a declining market, but you'll feel like the smartest person around when you ride the wave of the market recovery! Remember one of Buffett's most famous quotes: "Be fearful when others are greedy, and greedy when others are fearful."


Easy to say, much tougher to execute. So have a plan—expect the drop, and be ready to take action when it does.

And always—always—keep a long-term view.

*Want to know more about how to maximize your results?
Read my recommendations here*

No comments:

Post a Comment