The Stock Markets Have Given Up Making Sense

It’s looking terrible. It’s looking great. Now the Straits Times Index (SGX: ^STI) is looking quite terrible again. Those are the lamentations and celebrations of market commentators on an almost daily basis, since the start of the year.

One day the world can look as though it is racing off to hell in a handcart because oil has slipped below the so-called psychologically-important level of US$30 a barrel. And with the quick wave of a wand, the US stock market could easily stage a recovery of several hundred points that would make Lazarus’ rising look like a sideshow at a magician’s convention.

The Big “Three-Zero”

Exactly why US$30 has been chosen as a strategically-important price has never been properly expounded – or explained in even the briefest of details – to anyone. It certainly has a sense of arbitrariness about it.

But many investors are, nevertheless, happy to latch onto any conveniently-chosen round number, provided it is easy to remember. So, many market-watchers are now fixated on the big “three-zero”.

A price above US$30 a barrel is deemed to be good, for whatever reason commenters decide to choose, and stocks markets could respond positively to the higher cost of fuel. However, a drop of even one solitary cent below US$30 is perceived as being bad for the market, and equity markets around the world could respond by quickly tumbling out of bed.

Free money

But it is not only oil that has shaken stock markets around the world. The next interest-rate decision by the US Federal Reserve is also being closely monitored.

Last year, the market was obsessed by the timing of America’s normalisation of the cost of borrowing. At the time, a rate hike by the central bank was deemed to be bad, given that it could signal the end of the “free-money” that the US Federal Reserve had unintentionally flooded global economies with.

But then the market changed its tune. A rate hike was subsequently seen as a sign that the US economy was on the road to recovery. A recovery of the world’s largest economy was perceived to be a potential driver of economic growth in other parts of the globe.

What’s normal?

But as expected, with the first rate hike out of the way, the focus is now on when the next increase might take place.

Given the volatility of global stock markets since the start of the year, experts believe that it might be difficult for the Federal Reserve to increase interest rates four times this year. Some even believe that it was a mistake for the Federal Reserve to ever increase interest rates in December in the first place.

However, it is important to never try to second-guess the intentions of the US Federal Reserve – it has the ability to surprise. It has indicated that its future decisions on interest rates will be data dependent. If the data it is watching includes US employment levels and the rate of inflation in America, then a hike in interest rates is always a possibility, given that the numbers are robust.

Safe haven

Nevertheless, wild stock market fluctuations might cause the Federal Reserve to re-think the time scale for normalising interest rates. The volatile market has also prompted some investors to seek the solace of safe-haven assets such as gold.

Currently, the price of gold has surged to its highest level in more than two months. Some experts are predicting that the price of an ounce of the yellow metal could rise to levels not seen since September 2013.

However, it is important to remember that the price of gold could evaporate almost as quickly as it has hardened. It was only four years ago when gold was knocking on the doors of US$1,900 an ounce. Today it is worth 40% less. Consequently, holding an asset whose characteristics do not include the generation of regular income might not be so comforting in the long run.

The market might have given up making sense. But it doesn’t mean we should. When we invest it is vital continue to forecast the yield on an asset over the lifetime of the asset. If the asset does well, then we could be rewarded with not only regular income in the form of dividends but growth in the capital value of the asset over the long term too.

A version of this article first appeared in the Independent on Sunday.

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