Volatility is back

Written by multiforte on . Posted in News

It was a rollercoaster week. Here’s the daily gyrations of the S&P/ASX200 – just for last week:

  • Monday 5 February: -1.56%
  • Tuesday 6 February: -3.20%
  • Wednesday 7 February: +0.75%
  • Thursday 8 February: +0.24%
  • Friday 9 February: -0.89%

Down, down, up, up, down. It’s been a long time since we’ve seen any real kind of volatility.

This is the biggest dip since 30 June last year when the index 1.7%. And in fact, 2017 was a year of unusual calm in all major share and bond markets around the world.

Volatility’s return from its slumber is a salient reminder that sometimes markets are crazy – and that volatility is a normal part of investing.

You may be wondering what the future holds and if you should make changes to your portfolio. (You probably know we’re going to tell you not to react!)

The boring and honest truth is that a few (even large) down days is probably not going to change a thing for you as a long-term diversified investor.

In fact, reacting emotionally could harm your investment performance more than the market dip itself.

So, what caused the bout of volatility?

There are many opinions about what caused this latest bout of volatility in markets, coming as it did after a long period of relative calm.

While the explanations may sound plausible enough, the reality is it just happened.

The economy isn’t teetering on the brink of disaster. There’s no inflation running wild. There’s little sign of a US recession – in fact, we’re seeing the opposite, with high levels of confidence helping drive strong investment and consumer spending.

The point is there are any number of reasons markets may rise or fall on a given day – markets are complex, adaptive systems which are volatile by nature. Stocks go up and down as information and expectations change.

Daily declines don’t always result in negative annual returns

While a large market decline on a given day (or days) may seem like a harbinger of a bad year for investors, the evidence shows that these intra-year declines do not predict negative returns over the entire year.

For the Australian stock market (S&P/ASX 300) since 2001, the average intra-year decline was about 13%. About 60% of the years observed had declines of more than 10%, and about 40% had declines of more than 15%.

Yet despite substantial intra-year drops, the calendar year returns were positive in 14 years out of the 17 years in this period – despite each year having negative returns within the year, the market posted a positive annual return more than 80% of the time.

Which just goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline will result in negative returns over the entire year.

Seven ideas to help you keep calm

If you’re still feeling a little anxious, here are seven ideas to help you keep calm when faced with investment volatility.

1. Ignore the media

Remember that the role of the media is more about attracting your attention – and less about informing and educating. What’s more, markets are unpredictable and do not always react the way even the most seasoned experts predict they will. It’s pointless to speculate.

2. Someone is buying.

Quitting the equity market when prices are falling is like running away from a sale. When prices fall to reflect higher risk, that’s another way of saying expected returns are higher. And while the media headlines proclaim that “investors are dumping stocks”, remember someone is buying them. Those people are often the long-term investors.

3. Market timing is hard.

Recoveries can come just as quickly and as the prior correction. In 2008, the Australian share market fell by nearly 40%. Some investors sold out, only to see the market bounce by more than 37% in 2009 and rise in seven of the eight subsequent years. Attempting to market time creates the risk that you turn paper losses into real ones instead of waiting around for the recovery.

4. Remember the power of diversification.

When equity markets turn rocky, other assets like investment grade bonds may do well. This limits the downside for a diversified investor – diversification spreads risk and can lessen the volatility of your overall portfolio.

5. Markets and economies are different things.

The world economy is forever changing and new forces are replacing old ones. This applies both between and within economies. For instance, falling oil prices can be bad for the energy sector, but good for consumers. New economic forces are emerging as global measures of poverty, education and health improve.

6. This too shall pass.

Just as smart investors temper their enthusiasm in booms, they keep a reserve of optimism during busts.

And just as loading up on risk (equity type) assets when prices are high can leave you exposed to a correction, dumping these assets when prices are low means you can miss the turn when it comes.

7. Discipline is rewarded.

Market volatility does create some level of anxiety for most investors – which is completely understandable. The trick is to accept this – and then stick to your well-thought-out plan, continue to focus on your progress to your goals and accept how markets work.

Conclusion

While the current volatility may feel a little uncomfortable, remember it’s normal. Reacting emotionally and changing long-term investment strategies in response to short-term declines could be more harmful than helpful.

Sources: Dimensional Fund Advisors “Recent Market Volatility” (February 2018) and “Volatility: Seven Simple Lessons (February 2018); VanEck “Positioning for volatility with quality” (31/01/2018).