Broker Check

Volatility Here We Come

| December 23, 2018
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So where is that Santa Claus rally investors and pundits have been speaking about? Santa is coming soon but what about his stock market rally? There are only 4.5 trading days left in December! Let’s get busy Santa. And what about Jay Powell’s statement last Wednesday upset investors so much? Partial Government Shutdown? Tariffs…Brexit…These are just a few of our favorite topics we’ve been discussing lately. These last several months may have rocked the boat for markets and investors alike but it doesn’t necessarily mean our rally is coming to a close, at least not yet! 

Truth be told the markets haven’t seen this type of volatility for years. But the anticipation of a correction or worse has been on everyone’s mind as the markets continued to heat up without any signs of letting down for the past 9 years. Even for most of 2018 many of the major indices were still on track for a stellar year: 

YTD figures through September 30th, 2018 (courtesy of Koyfin)

  • The S&P 500 (SPY) was up 10.75%
  • The NASDAQ 100 (QQQ) was up 20.19%
  • Small Caps (IWM) were up 10.04%
  • International Developed Markets (EFA) were down -1.26%
  • Bonds (AGG) were down -1.76%

Then “The October Effect” happened, which erased many of the positive returns in 2018:

9/30/18 – 10/31/2018 – (Courtesy of Koyfin)

  • The S&P 500 (SPY) was down -6.91%
  • The NASDAQ 100 (QQQ) was down -8.60%
  • Small Caps (IWM) were down -10.99%
  • International Developed Markets (EFA) were down -8.24%
  • Bonds (AGG) were down -.64%

December hit and with only a few trading days left we are on track for another negative month.

So what’s the point to all of this? The point is that it’s actually normal! We just haven’t experienced this much volatility in a long time. A normal year of 1% gyrations in the stock market happens on average 61 times per year. This year we have had 60 ups and downs of 1% or more. (Goldman Sachs, 2018). Last year we had a total of 8, which is why it is now being called “the calmest year for markets in more than five decades”. (CNN Business, 2018)

Between 1980 and 2018 U.S. Markets experienced 36 corrections, or about one every year. A correction is defined as a market decline of 10% or more from a recent high. 

One could say that the market has been busy trying to keep up with the averages. All joking aside, volatility can be scary, but shouldn’t be worrisome. The S&P500 has spent 7,104 calendar days in correction since 1950 and more than 18,000 in expansion. Corrections last for an average of 196 calendar days which is less than 7 months. (The Motley Fool, 2018)

One of the few indices that have been up in 2018 has been the VIX. The VIX Index, often referred to as the “fear index”, represents the market’s expectation of 30-day forward looking volatility. It doesn’t take an Economist to figure out from this trend that investors are nervous (duh!). The Index started to increase in 2010 and anxiety increased along with it. Investors have been waiting for the shoe to drop ever since. 2008 has all but faded from recent memory and the truth is that we have just experienced the longest running bull market in history. But are we moving backwards now? Are we heading into a recession? None of the economic factors currently indicate that.

As Mohammed El-Arian said on Friday, "We've got to be careful because we can talk ourselves into a recession. And that's how bad technicals become bad economics”. (CNBC, 2018) 

Point taken Mr. El-Arian. So what should you do with your portfolio in light of all of this volatility? Move to cash? Increase bonds? Buy alternatives? Utilize options? Buy more stocks and bonds? Nothing? Of course, there is no one-size-fits-all solution, but in practice, using a strategic asset allocation (i.e. a diversified mix of investments spread out amongst many different categories: large companies, small companies, mid-size companies, international, fixed income, alternatives and cash) has proven to lessen volatility over the long haul. In the world of professional money management corrections are often used to rebalance portfolios, redistributing money to asset classes that have been underperforming, effectively buying in at low valuations or “on the dip” while selling out of positions that have typically done well (i.e. sell high/buy low mentality). Using this philosophy has helped us grow in good times and protect portfolios during market declines. 

This last chart below shows the benefits of diversification. Most major indices were down with the exception of bonds this month (December 1, 2018 - through December 21, 2018. Chart courtesy of Koyfin). By using a proxy for a diversified portfolio (Vanguard Lifestrategy Growth Fund – VSMGX), we can show how a mix of 60% stocks and 40% bonds held up compared to the rest of the market. And while this balanced fund is not the best performer of the month, it looks pretty good when stacked up against other major market indices. 

Staying the course and rebalancing is the most prudent (albeit potentially anxiety provoking) way to tackle the ups and downs of the stock market. Fundamentally, the US economy is still in really good shape. We anticipate growth in 2019 and once we can get past some of the political hurdles, we expect that the volatility will eventually subside. 

According to Goldman Sachs’ most recent economic outlook, global earnings growth is projected to increase by 8% in 2019 (i.e. economic expansion). (Goldman Sachs, 2018). Brad McMillan, Commonwealth’s own CFO recently said in his monthly December blog post “right now the conditions that historically have signaled a potential recession are not in place.” Furthermore, he stated “On an absolute basis, conditions remain good—with healthy job growth, high levels of consumer confidence, and expansionary business confidence.” He goes on to say that we should continue to expect some volatility but “the likelihood remains that the markets will rebound.” (McMillan, 2018) 

In summary, it’s normal to experience anxiety during these gyrations. I can assure you that we are doing everything we can to mitigate and minimize volatility. We started taking steps months ago to rebalance portfolios and added funds to help reduce risk and volatility. Using sound investment principals and a team of well-qualified investment professionals who we work with on a daily basis, I am extremely confident that we are well-equipped to navigate these choppy waters. 

If you are experiencing anything more than some mild uncomfortableness and want to discuss your portfolio, please reach out to me or anyone on our team so we can set up a time to talk. 

May this season bring you joy, happiness and peace amongst all of your family and friends. 

Happy Holidays, Happy New Year and we look forward to seeing you in 2019! 

Cheers, 

Adam, Julie, Arabelle, Joanna and Alan

 

References

CNBC (Belvedere, M.J.). (2018, December 21). El-Erian stunned by recession talk, warns of self-fulfilling prophecy. Retrieved from CNBC: Economy: https://www.cnbc.com/2018/12/21/mohamed-el-erian-stunned-by-recession-talk-warns-of-self-fulfilling-prophecy.html

CNN Business (Isidore, C.). (2018, April 3). 2018: When 400-point stock swings become normal. Retrieved from CNN Business: https://money.cnn.com/2018/04/03/investing/large-stock-market-swings-volatility/index.html

Goldman Sachs (Tousley, J. CFA). (2018). Market and Economic Perspectives: Pressure Points. New York: Goldman Sachs Asset Management.

McMillan, B. (2018, December 14). Monthly Market Risk Update: December 2018. Retrieved from The Independent Market Observer: https://blog.commonwealth.com/independent-market-observer/monthly-market-risk-update-december-2018

The Motley Fool (Williams, S.). (2018, December 19). 5 Stock Market Correction Statistics You Need to Know -- The Motley Fool. Retrieved from The Motley Fool: https://www.fool.com/investing/2018/12/19/5-stock-market-correction-statistics-you-need-to-k.aspx

 

 

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