When the Markets Fall!

When the Markets Fall!

Have you noticed that the Stock Market seems to be topping and running out of steam? You may not notice because you are listening to all the people who have done well in the markets in the past 4 years. So you are going to get in at the top and think you are going to do the same thing as they did. I agree somewhat with the ad that Josh Mellberg sent out by email; “98% possibility of 2014 stock crash?”  He claims that bubbles are all around us. Below is the Josh Mellberg’s ad.

Wall Street Journal’s MarketWatch contends as much from a poll, citing  “10 bubbles blowing into biggest crash in 30 years.”

http://www.marketwatch.com/story/10-investments-where-a-bubble-may-be-brewing-2013-11-12 Click on the link above. The next 10 investment bubbles

So many appear to be ignoring these indicators. Truth is, bubbles are everywhere.  Are they ready to pop? According to MarketWatch, the evidence is overwhelming,  and with only one clear outcome:

Up to 98% risk at the apex. This 2014 crash is effectively guaranteed. There’s a small 2% chance of dodging this bullet.

They claim that there is a 98% chance of a stock market crash in the year 2014. This part, I disagree with. Anything could happen but in my opinion, the stock market will correct itself but not have a bear market crash like we saw in 2006 to 2010 or in 1929.

What is Risk?

The stock market is filled with risk. You may ask, what is risk?

The chance that an investment's actual return will be different than expected. Risk includes the possibility of losing some or all of the original investment. Different versions of risk are usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment. A high standard deviation indicates a high degree of risk.

Many companies now allocate large amounts of money and time in developing risk management strategies to help manage risks associated with their business and investment dealings. A key component of the risk management process is risk assessment, which involves the determination of the risks surrounding a business or investment.

A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk that an investor is willing to take on, the greater the potential return. The reason for this is that investors need to be compensated for taking on additional risk.

For example, a U.S. Treasury bond is considered to be one of the safest (risk-free) investments and, when compared to a corporate bond, provides a lower rate of return. The reason for this is that a corporation is much more likely to go bankrupt than the U.S. government. Because the risk of investing in a corporate bond is higher, investors are offered a higher rate of return.

Market Risk is the possibility for an investor to experience losses due to factors that affect the overall performance of the financial markets. Market risk, also called "systematic risk," cannot be eliminated through diversification, though it can be hedged against. The risk that a major natural disaster will cause a decline in the market as a whole is an example of market risk. Other sources of market risk include recessions, political turmoil, changes in interest rates and terrorist attacks.

For the stock market, the two major categories of investment risk are market risk and specific risk. Specific risk, also called "unsystematic risk," is tied directly to the performance of a particular security and can be protected against through investment diversification. One example of unsystematic risk is that a company, whose stock you own will declare bankruptcy, thus making your stock worthless.

Operational Risk is a form of risk that summarizes the risks a company or firm undertakes when it attempts to operate within a given field or industry. Operational risk is the risk that is not inherent in financial, systematic or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risks resulting from breakdowns in internal procedures, people and systems.

Operational risk can be summarized as human risk; it is the risk of business operations failing due to human error. Operational risk will change from industry to industry, and is an important consideration to make when looking at potential investment decisions. Industries with lower human interaction are likely to have lower operational risk.

The possibility that shareholders will lose money when they invest in a company that has debt, if the company's cash flow proves inadequate to meet its financial obligations. When a company uses debt financing, its creditors will be repaid before its shareholders if the company becomes insolvent.

Investors can use a number of financial risk ratios to assess an investment's prospects. For example, the debt-to-capital ratio measures the proportion of debt used, given the total capital structure of the company. A high proportion of debt indicates a risky investment. Another ratio, the capital expenditure ratio, divides cash flow from operations by capital expenditures to see how much money a company will have left to keep the business running after it services its debt. Financial risk also refers to the possibility of a corporation or government defaulting on its bonds, which would cause those bondholders to lose money.

Now you can see why I invest 95% of my money in Corporate Bonds.