What’s Going On With The American Stock Market?

The American stock market has been exceptionally volatile this week — down, then up, then down again.

Editor’s Note: If you’re new to the U.S. stock market and do want to invest, there are many guides online to help you out.

The most recent drop was particularly steep. The Dow had its worst day of the year on Wednesday, when it dropped 800 points. (This came shortly after a previous “worst day of the year” on August 5, when it fell 767 points.)

The latest drop was, without a doubt, related to Wednesday’s yield curve inversion. The first time since June 2007 that 2-year Treasury Notes began trading above 10-year Treasury Notes. The yield curve has since un-inverted, but an inverted yield curve is a historic and fairly accurate recession predictor, even though the recession itself generally doesn’t begin for another one or two years — which is why those 2-year T-Notes, which should yield their returns before the recession begins, are suddenly more valuable than the notes that’ll come due in the middle of a recession that hasn’t happened yet. (If that doesn’t make you think of chickens and eggs and snakes eating their own tails, I don’t know what should.)

If you want a more technical analysis of what’s going on, here’s how Reuters explains it:

When short-term yields climb above longer-dated ones, it signals short-term borrowing costs are more expensive than longer-term loan costs.

Under these circumstances, companies often find it more expensive to fund their operations, and executives tend to temper or shelve investments. Consumer borrowing costs also rise and consumer spending, which accounts for more than two-thirds of U.S. economic activity, slows.

The economy eventually contracts and unemployment rises.

But we aren’t here to discuss the yield curve or the bond market — if you’re interested in learning more about what’s going on with T-Notes and American bonds, Lisa Rowan has a great explainer. Today we’re looking at the stock market and what all of this recent volatility means for you. Is it time to get off the stock market rollercoaster, or should you hang on for the ride?

The answer, as with nearly all questions related to the stock market, has to do with how much risk you’re willing to take.

CNBC interviewed behavioural economist Dan Ariely, who said that paying attention to market fluctuations is the biggest mistake you could make right now:

“If we’re going to look at it going up and down, we’re just going to be more miserable,” Ariely said. “We’re not only going to be more miserable, but act on it.”

Those moves often include fleeing from stocks to bonds or cash — investments with a higher expected value for those with a lower expected value.

“Historically, those are some of the biggest mistakes that people can make,” he said.

In other words, don’t assume you’re going to lose the value of your investments long-term. Dips will come, and recessions may even come, but buy and hold still works.

But what if you’re thinking more short-term? Like, what if you’re planning on retiring in the next ten years? What if you’ve been putting money into a brokerage account in the hopes of using it as a down payment? Should you sell now before things get any worse?

Here’s some data from MarketWatch that might help calm your nerves — or, at the least, help you make an informed decision:

On average, the S&P 500 has returned 2.5% after a yield-curve inversion in the three months after the episode, while it has gained 4.87% in the following six months, 13.48% a year after, 14.73% in the following two years, and 16.41% three years out, according to Dow Jones Market Data[.]

They also have a chart showing the length of time it took for the S&P 500 to rise to its newest peak following a yield curve inversion. On average, it takes 13.1 months for the market to hit its next peak; after the yield curve that preceded the Great Recession, it took 20.5.

I am a personal finance writer, not an investing professional, so I can’t give anyone any investment advice. But I can tell you that I’m not planning to change my investment strategy yet. I’m still planning on maxing out my retirement accounts and my HSA while putting additional money into a brokerage account to earn a higher return than I’ll get from a savings account or CD.

I’m in low-cost, passively managed index funds and ETFs, with 82 per cent in stocks (both domestic and international) and 18 per cent in bonds. I’ll still watch the market every day, mostly because I’m curious, but I’m not letting it worry me.

What about you?