Volatility works both ways

Today was another one for the record books, and thankfully it was on the upside! The Dow Jones average had a record point gain (though not a record percentage rise) of +936 points. That’s bigger by nearly 200 points than any of the large one-day drops we’ve had recently. The percentage gains were impressive as well: +11.1% for the Dow, +11.6% for the S&P 500 (now up +19.5% from it’s low last Friday), +15.9% for the EAFE (developed foreign markets), and +22.8% for emerging markets. Some individual stock gains were enormous: Morgan Stanley was up +87%. Today’s huge one-day move illustrates that volatility can work going up as well as going down. Expect to see a lot more big moves over the next few weeks, both up and down.

What propelled today’s jump, and will the rally continue? In other words, have we finally seen the bottom of this ferocious bear?

Answering either question requires some speculation, but it seems clear that worldwide government action over the weekend contributed to the turnaround. I won’t go into detail here on everything that transpired, but the message sent by governments everywhere was that they are committed to real action, and proved it by putting some unprecedented programs into place. One positive that didn’t involve direct government intervention was that the deal by Mitsubishi UFJ Bank to buy 21% of Morgan Stanley went through, albeit on somewhat less generous terms than initially proposed 2 weeks ago.

Since this is a market dominated by fear, anything that calms investors down and/or reduces uncertainty is likely to spur buying. But there are other factors at play that may conspire to create a very rapid recovery of the recent large losses. These include the cessation of margin calls, a massive short squeeze, and the settlement of the Lehman Bros. credit default swaps. All three of these are powerful, though arcane, influences on market prices.

I was going to explain each of these, but this post was getting too long. For now, suffice it to say that in addition to fear and the desire by many investors to own only the safest assets, internal market forces that contributed to the big drops of the last 2 weeks are now in decline. And they may continue to wane over the coming weeks, which is obviously a good thing.

So are we out of the woods yet? One day does not a bull market make, and we’ll almost certainly have some more chilling drops over the next few weeks as fear periodically resurfaces. Yet while it’s still too early to say with conviction that last Friday’s panic lows represent the ultimate bottom for this bear market, a number of factors are finally coming together that make this more likely than not. I also think it’s again safe to start buying stocks; even if you don’t catch the lows, you’re getting in at incredibly cheap prices.

As painful as the past year—and especially the past 2 weeks—has been, I believe that we’ll look back on October 2008 as one of the great buying opportunities of the 21st century. Those who purchased stocks this month—or didn’t throw in the towel on their existing stockholdings as so many other investors did—should enjoy returns well above average over the next decade or more.

Now more than ever, it’s crucial to focus on the long term. Today’s wild swings seem huge in comparison to what we’re used to, but in the long run, they’ll be just blips on a chart.