After a booming 2017 on Wall Street, the volatility that the markets have shown so far in 2018 is not unusual, said James Valentine, a clinical professor of finance in DePaul University’s Driehaus College of Business.
Valentine has spent his career researching the stock market, serving as an equity research analyst in both the US and Europe.
In this Q&A, Valentine explains the recent volatility in the market, how new tariffs affect it and what people should know before investing.
Why does the threat of a trade war affect the market so much?
The reality is, in a trade war there are going to be some companies that are winners and some that are losers. Initially what’s going to happen is you’ll see a dislocation of capital. For example, if an aircraft manufacturer were to get impacted by the trade war, it would have plants with excess planes that aren’t going to be needed, so their stock would do poorly. However, presumably, the stocks that are winning part of the trade war, let’s say, steel companies, would benefit. Nevertheless, it takes time for the assets to be re-allocated to the right sectors.
Why has volatility increased in the last few months following a period of steady growth?
With the Federal Reserve starting to tighten, interest rates beginning to rise, and inflation potentially coming into question, it's creating some unease in the marketplace relative to the euphoria we've had with the stock market since the November 2016 election. Higher inflation can be a good sign the economy is recovering, but it has a darker side in that corporate borrowing costs rise, which creates a drag on corporate earnings growth.
It’s also worth noting when interest rates rise it offers alternative investment opportunities for investors. As the investment appetite shifts from stocks to bonds, it has a negative impact on the stock market. Even though there are some forces working against the stock market, valuations are near 30-year highs, excluding crazy high levels during the internet bubble of the late-1990s.
What else can cause the stock market to go up or down?
Put simply, the stock market moves in the direction of expected corporate earnings growth and therefore anything that is likely to boost or impede corporate earnings is going to affect the market. Sometimes these events can be forecast with some level of accuracy, such as labor inflation. Others are completely unpredictable, such as natural disasters, election upsets, and terrorist attacks.
What do people need to know and consider when they are looking to invest in stocks?
Broadly speaking, you need to understand the risk level that you're taking on. Some investments are typically more volatile than others. Volatility and risk go hand in hand. Before you invest in anything, you need to understand the historical risk and if it’s likely to change in the future.
When deciding to put money in the stock market, it all comes down to considering your long-term objectives. Generally speaking, stocks are the best long-term performers among the major asset classes. But be careful about trying to time the market, because it has been proven time and time again that this is almost impossible, even for the savviest investors.