A recent news report stated that this year has been the worst start for U.S. stocks in history. The media’s use of terms such as “crisis” and “collapse” has contributed to an increase in investor anxiety, opening the door for emotionally driven decisions.
What can advisors do to help clients avoid the mistakes often made during times like these? If we have a good understanding of the situation and communicate this to our clients, it should provide perspective and reduce irrational decisions. In this post, we will review the purpose of the financial markets; examine the causes of financial disruptions, and discuss what an advisor can do to help clients.
The Purpose of the Capital Markets
The recent selloff is certainly nothing new. It has happened before and will repeat itself many times in the future. To have the proper perspective, one must understand the purpose and function of the capital (i.e., financial) markets. The capital markets are the intermediary between investor and recipient. The recipients include businesses and governments around the globe. These entities require capital to operate and investors seek a profit. The financial markets are the vehicle that transports money from investor to recipient. Academically speaking, this process should follow a relatively smooth path with minimal disruption. In reality, however, disruptions are a common occurrence. Let’s look at the catalysts behind these disruptions.
The Causes of Financial Market Disruptions
Two primary issues cause a market disruption. They are macroeconomic policy and market excesses. Most disruptions stem from a combination of both and the current global selloff is no exception.
Here is a good example to explain how macroeconomic policies can cause a market excess and subsequent disruption.