Have you ever received a gift you did not actually want? Well, company 401(k) participants got a gift recently – the kind nobody wants. I am not talking about an ugly sweater or a pair of socks. I am referring to a new bout of stock and bond market volatility., just in time for the holidays.
The Dow Jones Industrials fell over 900 points the day after Thanksgiving. This event gives a whole new meaning to the term “Black Friday.” The popular stock market average then it slid a further 650 points on November 30th.
So, what is the cause of this winter wobble? Three familiar pandemic drama characters: COVID-19, inflation, and the Federal Reserve. Let us recap what is going on and then discuss what 401(k) investors can do about it.
The Omicron Variant
On November 26th, the World Health Organization announced the discovery of a new variant of COVID-19 designated as Omicron. This new variant was first discovered in South Africa. It contains “an unusually substantial number of mutations” from the original COVID-19 virus.
Here is what we do not know: Is Omicron more contagious? Is it more virulent? Can it evade the protection offered by vaccines? Scientists are racing to find the answers, but until they do, the rest of us must wait.
The stock and bond markets hate unknowns. When faced with too many – especially on such an important subject – the reaction tends to be fear and panic. And the first reaction is to “sell.”
Scientists always produce more questions. For example, if Omicron is more contagious, will it lead to new lockdowns and restrictions? Will that derail the economic recovery? If so, would that also overturn the bull market?
Another unknown: How will Omicron affect our second character, inflation?
Inflation
As you know, inflation has risen sharply in 2021. While inflation does not impact stocks as much as bonds. But even the hint of inflation can spook investors. Higher inflation leads to higher interest rates and lower corporate profits.
Inflation also increases the cost of doing business. It becomes harder for companies to hire new employees or buy new equipment. This eats into profits further still.
With Omicron, experts are trying to figure out what the new variant will do to inflation. There are three possibilities.
First, if Omicron were to cause an economic slowdown, then that would dampen inflation. (Remember, inflation increases when demand outpaces supply.) But if demand were to fall, inflation would, too. An economic slowdown is not the remedy anyone would choose to fight inflation.
The second possibility is the exact opposite: Omicron could make inflation worse. Imagine that Omicron does not need a new wave of restrictions here in the States. In that case, the economy would not harmed too much. But there is more to the world than the United States.
If other nations were to get hit hard by Omicron, it could further snarl supply chains. The supply of goods is already struggling to keep up with demand.
The third possibility is that Omicron turns out to have little to no effect on inflation or the economy. These unknowns are giving our third character a major headache.
The Federal Reserve
Since the pandemic began, the Federal Reserve has tried to prop up the economy. Interest rates are near zero. But inflation is on the rise, and the Fed recently signaled plans to wind down their stimulus efforts.
Their reasoning? The economy is strong, and inflation does not seem to be going away, so it is time to start raising interest rates. (Higher interest rates tend to cool off the economy. A cooler economy decreases inflation, and things gradually go back to normal.)
The problem is the stock market has become accustomed to the Fed’s low interest, “easy money” policies. Low interest rates drive more into the stock market to get higher investment returns. Higher interest rates could reverse this trend. That is why investors do not like any talk of the Fed “tapering” their stimulus program.
On Monday, November 29th, the Chairman of the Federal Reserve announced that a tapering action might happen soon. The announcement was too much for investors to manage along with the news on the Omicron variant.
So, what do you do now with your 401(k) account?
Make only the investment management decisions in your 401(k) account you know to be sound. Do not react emotionally. Do not guess. And for heaven’s sake, do not continue to “buy-and-hope.”
The individual 401(k) advice I provide my clients relies on years of training and experience. The most important investment management rules now are about principal preservation.
Right now, the markets are beset with unknowns. So, we will follow the rules that tell us when it is time to go on offense and when it is time to play defense. Technical analysis signals will tell it is time to sell a 401(k) mutual fund. Retirement plan principal must be protected at all costs.
That is how we manage stock market risk. That is how to give yourself the kind of gift every investor wants. Confidence in your 401(k) account decisions.
Ric Lager
Lager & Company, Inc.
