"Information is a source of learning. But unless it is organized, processed and available to the right people in a format for decision-making, it is a burden, not a benefit."
In the past few months, the barrage of news has come at our clients at a breakneck pace. First, it was the European debt crisis, next it was an earthquake in Haiti, then Japan's earthquake and tsunami and the subsequent threat of nuclear disaster. Such cataclysms by themselves strike fear in most investors, but coupled with wars in Iraq and Afghanistan, uprisings in Libya, Egypt and elsewhere and the stalemate in Congress over fiscal policy, they could likely prompt some investors to the sidelines, or perhaps the exits.
According to the Investment Company Institute, investors in January 2011 put about $636 million per day into equity mutual funds on average while withdrawing approximately $59 million per day from fixed-income funds. But during the month ending March 31, a key month because of the Libyan uprising and other major geopolitical events, equity mutual funds had net inflows of only about $172 million per day, while fixed-income funds had inflows of approximately $371 million per day. Further evidence of this growing uncertainty in equity markets is seen in the mutual fund flow data for April 2011, where fixed-income fund inflows were nearly three times the amount of equity fund investments.
The human tragedy and devastation of the earthquake and tsunami that hit Japan on March 11 also sent investors scrambling. The impact on the U.S. markets was muted at first; however, the weeks to follow saw a large increase in outflows from equity mutual funds, and an inflow was expected in fixed-income mutual funds. While the long-term effects of the earthquake and tsunami can't be understood yet, we have not so far seen a dramatic market impact like the one following the Kobe earthquake in 1995.
The S&P 500 was down approximately 37% in 2008 and was up approximately 26.46% and 15.06% in 2009 and 2010, respectively. The dramatic change in the S&P 500 and other equity values has allowed me to observe a different mentality in the way some clients look at their investments. There is a renewed sense that making quick changes to investment accounts to deal with these issues is prudent today when it wasn't considered that way in the past. The sheer momentum of the recovery we have seen in the equity markets over the past few years appears to be slowing a bit. Coupled with the global tumult of recent months, investors appear somewhat leery and they want to take profits before the next big crisis comes.
The CBOE Volatility Index, a key measure of the market expectations for near-term volatility as conveyed by S&P 500 stock index option prices, hit its all-time high in 2000, spiking to above 80-more than four times its normal average. Recent market events have caused additional spikes in the volatility index, suggesting that investors are nervous about the events in the Middle East, Japan and the United States. For example, during the week of March 21, a record number of 1 million volatility options traded on the exchange and the volatility index spiked to almost 31. As the initial shock and resulting news coverage of the March events has dissipated, the CBOE Volatility Index has collapsed almost 50% through the beginning of May 2011.
In addition to an outflow from equity mutual funds, we saw a similar shift into hard assets such as gold, silver and agricultural commodities. The CRB index, which comprises 19 different commodities traded on various market exchanges, trended up in the weeks during and following the events in March, moving from 340 in the middle of March to around 360 as of April 7, 2011, an increase of 6%. Gold and silver have also continued their rise in lockstep with global news. Despite a recent correction in the commodities market, many still believe that the longer term uptrend in commodities is still intact and may continue.
Over the past three to four years, I have seen a tremendous shift in clients' questions about their investment plans. We now live in a world where information flows so quickly that sometimes we can all get overwhelmed with the amount of information that we receive in a day. Clients ask about small bits of information they get from television, social media sites and blogs. Unfortunately, most of them lack the financial background or desire to organize this data into a rational framework for making decisions. This education and knowledge are the primary tools that help people rationalize what is happening in our world without making emotional decisions.
"The world is only going to end once, and the odds are that it isn't now." -Unknown
It is impossible to predict the future. Although many predictions were made about the markets and their path for 2011, not many people would have factored in a nuclear crisis in Japan or major developments in Libya and Egypt. Still, these events are not unlike many that have unfolded in the past: the Internet bubble, which abruptly ended in March 2000, the Cuban Missile Crisis in 1962 or the inflation of the 1970s. Even the current U.S. budget problems are certainly not a new phenomenon.