What's the Deal With This Stock Market Volatility?

It seems like we can't get through a day without the Dow Jones Industrial Average going up or down by a few hundred points. There are a few possible reasons, among them the U.S./China trade war and interest rate swings.

In this Industry Focus: Financials clip, host Jason Moser and Motley Fool contributor Matt Frankel, CFP discuss what's going on and how long-term investors should think about the recent market actions.

A full transcript follows the video.

This video was recorded on Dec. 10, 2018.

Jason Moser: Matt, leading into this week, the end of last week, this has been a tremendous past few days for the market, not in a good way. It seems like there has been an awful lot of selling, a lot of people running for the exits here for whatever reason. It seems like we could probably pinpoint a few different headlines to this behavior. Regardless, it's a very good lesson for all investors. Investing is never a straight line up. We talk about this, and the reasons why we believe that long-term investing works. Generally speaking, the numbers bear that out, but it doesn't come without its lumps in the short run. We've certainly seen and taken a few of those lumps here the past few days.

What stands out to you in regard to this market selling? What should we as investors be doing about it?

Matt Frankel: There's a couple of main root causes that we could pinpoint. The trade war/ skirmish/ whatever you want to call it is an obvious one. Not necessarily that it's going to be bad in the long run. If you haven't been following the news, the U.S. and China agreed to a 90-day period starting December 1st to continue their trade talks, to try to find a deal, and the U.S. backed off on some of its tariffs. Most experts think a deal will eventually happen. Nobody wants 25% tariffs. But certain things need to happen. China has been acting unfairly for some time. This isn't a long-term negative, but it's very uncertain in the meantime, and the market hates uncertainty, which is why every time a headline, good or bad, involving trade pops up, you see the market go crazy one way or the other. That's definitely one factor that seems to be making the market a little more volatile than usual.

The other thing, interest rates. People are uncertain about how the economy is slowing down, if at all. The latest talk is that the Fed might have to pump the brakes when it comes to raising interest rates. If you haven't been reading up on the Fed's reports, after the latest Fed meeting, the general consensus was that they're going to raise rates in December and another three times in 2019. That's a pretty aggressive plan. But the latest indication is that that might not happen at all. They might raise in December and then call it quits for the time being. They might not go in December at all, is the latest rumor.

Moser: What's the value in all this prognosticating? I don't mean to interrupt you there, but it seems like every day, this narrative changes a little bit. I'm sure that investors get frustrated by it. Where's the value in that prognostication? Should it even be something that's practiced?

Frankel: I mean, projections are always useful. I tend to look at the Fed's projections more than the experts on CNBC or any of the headlines I read. If the Fed says the economy is good enough to raise rates in December, and they're the ones who are actually going to make the decision, it makes sense to me that they're the ones who I'm going to listen to.

Moser: Makes sense.

Frankel: Having said that, there's a lot of noise out there. Investors are emotional beings and tend to overreact to things. If one whisper says the economy might be slowing down, someone else is going to find a reason why that might be true, and then another reason, and before you know it... this is the most pessimistic I've ever seen it when unemployment was below 4%, wages are growing. So, yes, there's some value in it, but don't confuse good projections with noise. That's a good way to put it.

Moser: Yeah, I think that makes sense. We talked about this all week last week, and over the weekend leading into today. The one thing that stands out to me, that we've seen a lot of talk about, is in regard to the yield curve, this flattening and inversion of the yield curve. I'll let you explain that in just a second. But, I think ultimately, what I've taken away from this is, even the talk about it, there are these big trading platforms, these institutional investors that rely a lot today on algorithms and programmatic trading to buy and sell at given points in time. This flattening of the yield curve seems to be one of those rules that dictates those algorithms. So, it's almost like it's beyond human control. It's just, if this happens, then this happens, then boom, the computer says, "Sell." Then you see this flood of selling, and there's nothing that can be done to stop it.

Talk a little bit about this yield curve -- what it is and why it matters or shouldn't matter for investors.

Frankel: The yield curve basically refers to the different durations of interest-bearing investments, bonds specifically. In a healthy market, the longer maturity a bond is, the higher an interest rate's going to pay. For example, a 10-year bond should pay more than a comparable five-year bond, which should pay more than a two-year bond, and so on and so on. In a healthy market, you might see a 2% yield on the two-year, a 3% yield on the five-year, a 4% on the 10-year, something like that. A flat yield curve means that the rates are getting very similar, which is where we're at right now. Other than the 30-year, pretty much all of the yields from Treasury bonds are between 2.5-3%. That's a pretty flat yield curve historically speaking.

What an inversion means is, the longer-maturity bonds actually pay out lower rates than some of the shorter-maturity bonds. We have what I call a partial inversion right now. As we're talking, glancing over at my notes, the two-year Treasury yields slightly more than the five-year. A textbook curve inversion would be the two-year and the 10-year flip-flopping. As you mentioned, algorithmic trading tends to take its cues from things like this. If we see the two-year and 10-year yield invert -- right now, they're about 14 basis points apart, so there's a little breathing room -- it could be look-out-below when it comes to algorithmic selling.

Moser: Yeah, and there's nothing we can do about that. I know they've tried to place some stop-gaps in there. If the market falls, what is it, 10% in any given day, trading immediately halts so that everybody can catch a breath and try to make sure that the world isn't actually coming to an end.

What I'm gathering from what you're saying is, for investors like us, business-focused investors, when we're looking at companies that we want to own, this yield curve doesn't really matter all that much in the grand scheme of things. Amazon is still going to be Amazon regardless of what this yield curve is doing, right?

Frankel: Right. If anything, this creates some good buying opportunities for long-minded investors. There's nothing interest rates are doing that's going to affect anything 20 years from now. If you're investing for the long haul, the market's going on sale, especially in some sectors.

Inverted yield curves also tend to be recession predictors. They're not perfectly reliable. A recession usually happens a year or two after you get an inverted yield curve. The financial industry is really heavily affected. This is the Financials show. That's why bank stocks are one of the hardest-hit parts of the market over the past few days when interest rates have been going crazy. This is creating a lot of little pockets of the market that are trading at really steep discounts. In the short-term, it could be for a reason. Lower long-term yields, we've discussed in previous episodes, tend to weigh on bank profits. Banks could see profits shrink in the short-term over this. But over the long-term, Bank of America is still Bank of America. Wells Fargo is still Wells Fargo. Goldman Sachs is still Goldman Sachs, one of the biggest investment banks in the world. The yield curve is doing nothing to the underlying business health of most of these businesses, for the time being, anyway. It could go in an extreme direction. If we have an extreme inversion, that could really hurt some of these bank profits to the point where it could affect their business. But I don't see that happening anytime soon. The bottom line is, from a long-term perspective, you can go bargain hunting at these prices.

Moser: That's good information to know. I'm sure our listeners appreciate it.