Last week, the markets were on a wild roller coaster ride, with US stock markets initially falling significantly and closing the week higher. On Friday the S&P 500 Index ended higher by 1 percent, while the Nasdaq 100 Index and Dow Jones Industrial Average recorded their best week in nearly 2 months.
Some people might consider the unusual market volatility that occurred last week as nothing but a fit of market irrationality that is insignificant and can easily be reversed. However, this kind of thinking would be improper. It’s like hastily arriving at a conclusion that walking on a tightrope without a harness is completely safe just because you were able to do so once strangely without incurring any harm.
Several indicators confirmed that the previous week was notable and even historic. Records were set, such as the largest intraday reversal and the biggest daily move.
For instance, the Dow Jones moved by an impressive 10,000 points within just 5 trading sessions. On the other hand, the VIX skyrocketed to levels not reached since the worst of the global financial crisis in 2008. Furthermore, the currencies of emerging countries slumped below the levels hit during the worst days of the 2008 crisis.
Some investors think that the final destination is more important than the journey. Hence, they believe that the unusual volatility last week does not really have a predictive value.
However, that is absolutely untrue. The market events last week just goes to show that the fundamentals of financial markets are clearly fragile. This puts the health of the global economy in question and might possibly create uncertainty of prices.
Aside from that, it seems like retail investors cannot endure such outbursts of volatility, leading to massive disposals of equity mutual funds. Also during these bouts of severe volatility, the good investments get washed out with the bad ones. This is especially true for widely held investments, such as Google (NASDAQ:GOOGL) and Apple (NASDAQ:AAPL), which investors run to when they are trying to raise cash. When overleveraged, investors and traders have to sell as thorough selection of assets and allocations for a diversified portfolio become less of a shield.
Lastly, though central bank officials are still interested to limit such bouts of market volatility, they have already done so much through quantitative easing programs and floored interest rates. Therefore, the monetary policy efforts in China and the calming comments of the New York Federal Reserve President in the previous week could soon be tested by events on the ground.
Knowing that the financial markets may be subjected to more wild rides, it is advisable for investors to quickly evaluate if they can endure this type of market volatility again without being forced to sell during bad times and also whether they have sufficient financial firepower to buy bargains that arise during these episodes of market turmoil.