Making Sense of Current Market Volatility

by | Dec 23, 2018 | Investment Strategies, Market + Economic Perspectives | 0 comments

As of yesterday’s market close, the S&P 500 is at a 15-month low, with 60% of its stocks in what is considered, “bear market” territory (down 20% or more) and 9 of 11 industry sectors now trading at what is considered “correction” levels (down 10% or more).  I’m sure investors don’t really care what it is called (bear market or correction), the bottom line is that the markets have been awful for investors since October.  In fact, the equity markets are now officially having the worst year since 2008.

Now for the positive part, this too shall pass! While there are valid reasons for the markets to periodically correct and also for the increase in volatility, we do believe there is a disconnect between current valuations and actual economic realities. Yes, there are changes with Fed policy that the markets need to adjust to and there are also signs that the economy has peaked and may slow going into 2019. However, does any economic data actually indicate that there are signs of a recession looming around the corner?  Absolutely not!

On Wednesday, the Fed raised its benchmark lending target rate by a quarter percentage point to the range of 2.25-2.50% citing continued strong economic activity, including jobs and household-spending growth. The Fed also noted inflation remains near the 2 percent target, and longer-term inflation expectations remain unchanged.  In fact, the Federal Reserve policymakers only made modest revisions to their economic outlook by slightly reducing growth expectations for 2018 to 3.0 percent, down from 3.1 percent in September. They also lowered their growth forecast for 2019, from 2.5 percent to 2.3 percent. In other words, the economy is still expected to grow for the foreseeable future, no recession.  

Just the opposite, indicators show that the economy is on track for the fastest annual growth in more than a decade and on average, economists are projecting approximately 2.5% growth in 2019.  But yet, the financial media is still solely focused on doom and gloom.

So, why are the markets going so crazy?  Well, on any given day the talking heads on TV will give you a sound bite or a headline to dramatize the day’s activity and explain it but it comes down to one word, uncertainty!  The market hates uncertainty and the fear of the unknown.  That fear feeds on itself, effectively reducing buyers willing to commit capital and voila, short-term momentum traders and the “machines” that trade on algorithms takes over. 

In this type of environment, the market swings are fast and extreme and economic fundamentals and valuations really mean nothing.  When technical support levels that traders and market technicians follow on charts break, it then triggers, even more selling, exacerbating the activity.  It’s a vicious cycle but once it begins, it unfortunately just has to run its course.  At some point, however, and usually when the fear is at its highest level, it will turn.  Money managers and opportunistic traders will step in to scoop up oversold values and we could possibly see a “melt up”.  We’ve seen this before.

Unfortunately, the average person with money invested for their future is along for the roller coaster ride.  There are a few rules that I believe should be followed.  It is very important to avoid the urge to get caught up in day-to-day market movements that may cause you to make investment decisions based on emotion. Instead, focus on your specific investment objectives and most importantly, define your investment time frame.  If you have investments that are earmarked for a short-term need (let’s say under 1 year), then those funds should not be in the stock market!  

For the most part, investors should stay the course, have a plan, stay diversified, review your short and intermediate term income and liquidity needs, and understand your tolerance risk.  For this reason, I believe it is important to have an advisor that can help guide you through times like this.  Of course, I am biased on that subject as this is what we do and we can help!

Additional thoughts on why the high level of market volatility.

As mentioned above, on any given day we have multiple news headlines that may add to the wall of worry and spark the days market mood and activity. In our opinion, what is also adding and driving much of the market stress is what you may have heard being called “normalization”.  Basically, the gradual removal of the added economic stimulus from the Federal Reserve, or Quantitative Easing also known as QE.  After the financial crisis of 2008-09, central banks around the world added fixed income assets to their balance sheets. This was done to add stimulus to their economies by keeping interest rates on government bonds lower than they might otherwise be.  

Now that we have a had a decade of artificially maintained low interest rates, the markets need to adjust to the new reality of less central bank liquidity and economic stimulus. The unknown future effect on the markets and the economy now adds to the uncertainty. We also believe that the over the past few years, the added stimulus from QE likely reduced market volatility.  The increase in volatility today may be reflecting normalization in the markets, particularly given the late stage of the current business cycle and how well the equity markets performed from 2009 to 2017.

The world and the investment landscape has changed dramatically over the past 10 years and we believe it is very important for investors to adjust their investment strategies accordingly. What was smart 10 years ago, may not be so smart today! Is your portfolio positioned for today’s economic realities and your specific needs?

At PWA, we can help you with a complimentary Risk Analysis Review. We use sophisticated portfolio analytics tools that run stress tests on how a portfolio would have performed under several different economic and market scenarios. The more informed you are about risks and how your investments are positioned, the more you can relax, sleep well, and enjoy the things you love most.

Contact us at 800-499-4143 extension 3 or send an email to info@yourpremierwealth.com with any questions you may have.

We want to wish our clients, friends, and associates a very healthy, peaceful, and happy holiday season and all the best in the New Year!

John L. Diaz, CFP® / President & Senior Wealth Strategist

Eleven Ways to Help Yourself Stay Sane in a Crazy Market

Keeping your cool can be hard to do when the market goes on one of its periodic roller-coaster rides. It’s important to put the volatility on context It’s useful to have strategies in place that prepare you both financially and psychologically to handle market volatility. Of course, I’m biased towards the benefits of having a competent advisor that is helping you align your portfolio with your specific needs and tolerance for risk.

Just in case, however, here are 11 ways to help keep yourself from making hasty decisions that could have a long-term impact on your ability to achieve your financial goals.

1. Have a game plan

Having predetermined guidelines that recognize the potential for turbulent times can help prevent emotion from dictating your decisions. For example, you might take a core-and-satellite approach, combining the use of buy-and-hold principles for the bulk of your portfolio with tactical investing based on a shorter-term market outlook. You also can use diversification to try to offset the risks of certain holdings with those of others. Diversification may not ensure a profit or guarantee against a loss, but it can help you understand and balance your risk in advance. And if you’re an active investor, a trading discipline can help you stick to a long-term strategy. For example, you might determine in advance that you will take profits when a security or index rises by a certain percentage, and buy when it has fallen by a set percentage.

2. Know what you own and why you own it

When the market goes off the tracks, knowing why you originally made a specific investment can help you evaluate whether your reasons still hold, regardless of what the overall market is doing. Understanding how a specific holding fits in your portfolio also can help you consider whether a lower price might actually represent a buying opportunity.

And if you don’t understand why a security is in your portfolio, find out. That knowledge can be particularly important when the market goes south, especially if you’re considering replacing your current holding with another investment.

3. Remember that everything is relative

Most of the variance in the returns of different portfolios can generally be attributed to their asset allocations. If you’ve got a well-diversified portfolio that includes multiple asset classes, it could be useful to compare its overall performance to relevant benchmarks. If you find that your investments are performing in line with those benchmarks, that realization might help you feel better about your overall strategy.

Even a diversified portfolio is no guarantee that you won’t suffer losses, of course. But diversification means that just because the S&P 500 might have dropped 10% or 20% doesn’t necessarily mean your overall portfolio is down by the same amount.

4. Tell yourself that this too shall pass

The financial markets are historically cyclical. Even if you wish you had sold at what turned out to be a market peak, or regret having sat out a buying opportunity, you may well get another chance at some point. Even if you’re considering changes, a volatile market can be an inopportune time to turn your portfolio inside out. A well-thought-out asset allocation is still the basis of good investment planning.

5. Be willing to learn from your mistakes

Anyone can look good during bull markets; smart investors are produced by the inevitable rough patches. Even the best investors aren’t right all the time. If an earlier choice now seems rash, sometimes the best strategy is to take a tax loss, learn from the experience, and apply the lesson to future decisions. Expert help can prepare you and your portfolio to both weathers and take advantage of the market’s ups and downs. There is no assurance that working with a financial professional will improve investment results.

6. Consider playing defense

During volatile periods in the stock market, many investors reexamine their allocation to such defensive sectors as consumer staples or utilities (though like all stocks, those sectors involve their own risks, and are not necessarily immune from overall market movements). Dividends also can help cushion the impact of price swings.

7. Stay on course by continuing to save

Even if the value of your holdings fluctuates, regularly adding to an account designed for a long-term goal may cushion the emotional impact of market swings. If losses are offset even in part by new savings, your bottom-line number might not be quite so discouraging.

If you’re using dollar-cost averaging — investing a specific amount regularly regardless of fluctuating price levels — you may be getting a bargain by buying when prices are down. However, dollar cost averaging can’t guarantee a profit or protect against a loss. Also consider your ability to continue purchases through market slumps; systematic investing doesn’t work if you stop when prices are down. Finally, remember that the return and principal value of your investments will fluctuate with changes in market conditions, and shares may be worth more or less than their original cost when you sell them.

8. Use cash to help manage your mindset

Cash can be the financial equivalent of taking deep breaths to relax. It can enhance your ability to make thoughtful decisions instead of impulsive ones. If you’ve established an appropriate asset allocation, you should have resources on hand to prevent having to sell stocks to meet ordinary expenses or, if you’ve used leverage, a margin call. Having a cash cushion coupled with a disciplined investing strategy can change your perspective on market volatility. Knowing that you’re positioned to take advantage of a downturn by picking up bargains may increase your ability to be patient.

9. Remember your roadmap!

Solid asset allocation is the basis of sound investing. One of the reasons a diversified portfolio is so important is that strong performance of some investments may help offset poor performance by others. Even with an appropriate asset allocation, some parts of a portfolio may struggle at any given time. Timing the market can be challenging under the best of circumstances; wildly volatile markets can magnify the impact of making a wrong decision just as the market is about to move in an unexpected direction, either up or down. Make sure your asset allocation is appropriate before making drastic changes.

10. Look in the rear-view mirror

If you’re investing long-term, sometimes it helps to take a look back and see how far you’ve come. If your portfolio is down this year, it can be easy to forget any progress you may already have made over the years. Though past performance is no guarantee of future returns, of course, the stock market’s long-term direction has historically been up. With stocks, it’s important to remember that having an investing strategy is only half the battle; the other half is being able to stick to it. Even if you’re able to avoid losses by being out of the market, will you know when to get back in? If patience has helped you build a nest egg, it just might be useful now, too.

11. Take it easy

If you feel you need to make changes in your portfolio, there are ways to do so short of a total makeover. You could test the waters by redirecting a small percentage of one asset class to another. You could put any new money into investments you feel are well-positioned for the future, but leave the rest as is. You could set a stop-loss order to prevent an investment from falling below a certain level, or have an informal threshold below which you will not allow an investment to fall before selling. Even if you need or want to adjust your portfolio during a period of turmoil, those changes can — and probably should — happen in gradual steps. Taking gradual steps is one way to spread your risk over time, as well as over a variety of asset classes.

1 Google Finance, September 26, 2018
2 The Wall Street Journal, September 23, 2018, http://go.steadyinvestor.com/e/279272/ons-1537698598-mod-djem10point/3g69x/286188741
3 The Wall Street Journal, September 24, 2018, http://go.steadyinvestor.com/e/279272/ect-1537777015-mod-djem10point/3g69z/286188741

Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.

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