Navigating a Nervous Market
Keeping cool when stock market volatility heats up has its benefits.
In a year of unpleasant surprises — I’m personally talking about
the Chicago Blackhawks failing to make the NHL playoffs for the
first time in 10 years — perhaps the most frustrating and worrisome
is the return of volatility to the U.S. and global stock markets. It
affects our, and our clients’ wealth, and it’s something we haven’t
had to stress over for nearly a decade.
Between Nov. 8, 2016 (Election Day) and Jan. 26, 2018, the Dow
Jones Industrial Average, or Dow 30, rose more than 8,283 points,
for a gain of more than 45 percent — a stunning return for just 15
months. But by March 31, just two months later, the Dow closed
almost 2,514 points lower, for a quick loss of about 9 percent in
reaction to growing geopolitical tensions, trade war talks, rising
interest rates, and more. Then all the chatter about steep corrections,
bear markets, and the party ending for stocks began.
We as investors may know that stock prices rise and fall daily. But
in all honestly, it’s much easier to accept this investing truth during
a year like 2017 where stock prices generally marched higher with
no meaningful pauses or pullbacks, and certainly no “corrections”
(a decline of more than 10 percent from the high). So far this year,
it feels like prices fall more often than rise, volatility is back (the
S&P 500 experienced swings of 1 percent or more in 51 percent of
its Q1 trading days), and tensions and stressors are once again part
of investors’ daily lives.
So, what gives? Should we worry about renewed market swings?
Is there a way to profit from volatility? Or, is it time to seek out
VOLATILITY: THE HISTORY
According to online financial news and information provider
Investopedia, volatility is “the amount of price change a security
experiences over a given period of time. If price stays relatively
stable, the security has low volatility. A highly volatile security is
one that hits new highs and lows, moves erratically, and
experiences rapid increases and dramatic falls.”
Volatility is rarely a worry when prices are rising, but it quickly
becomes an investor concern when prices reverse course. Financial
analysts often refer to the VIX measure, or “Fear Index,” when
discussing market volatility. The VIX is the ticker symbol for the Chicago Board Options Exchange’s (CBOE) Volatility Index, a
weighted measure of the implied volatility of multiple S&P 500 put
and call options. Like stock prices, the VIX is computed continuously
throughout the trading day. The VIX standing at 30 or more implies
greater stock market “fear,” aka volatility, while a drop below 20
means little to no significant stock market volatility persists.
According to the CBOE, the average VIX index daily closing price
between 1990 and 2017 was 19.37, with a range of 9.14 to 80.86.
In 2017, the VIX range was 9.19 to 16.04. However, in just the first
quarter of 2018, the VIX range expanded to 9.15 to 33.46. Clearly,
volatility is making a strong comeback. But it’s important to
remember that we’ve seen periods of high volatility before, as
evidenced by the significantly higher end of the long-term range
(80.9) versus the current period range (33.5). It’s fair to say that, in
general, the recent volatility we’ve experienced in the market
should be no more worrisome to investors than past periods of
elevated volatility. In other words, I don’t believe we are seeing
anything new here even if it feels uncomfortable for the time being.
PROFITING FROM VOLATILITY
One way to take advantage of this edgy environment is to purchase
exchange-traded funds (ETFs) and other investment products
designed to rise in value in times of relatively higher volatility.
Essentially, these products hold VIX options and futures contracts
and may also use leverage to enhance returns. This isn’t without
risk, so I recommend these for short-term trading vehicles rather
than long-term holdings. Accordingly, you’ll need to monitor price
changes closely. Timing the markets is never easy, but active
traders can further use these vehicles to profit from market swings
or hedge their bets.
Investors with long time horizons, say 10 years or more, should
embrace higher volatility, which will help rather than hurt in the
long run. While it may be difficult to watch the ups and downs of
your portfolio value during this period of higher volatility, keep in
mind that you aren’t actually affected until you sell off investments
and start making withdrawals. Second, the longer you’re in the
market before needing the funds, the better the odds that your
portfolio value will recover from any prolonged retractions.
Further, volatility also helps if you’re regularly making deposits and
stock purchases in your portfolio, like payroll contributions in a
401(k) plan. This is because at least some of those deposits will be
made at lower/falling stock prices and your fixed deposit amount
allows you to purchase more shares, relative to higher prices. As
the market recovers, those incremental share purchases will further
increase your portfolio value. Younger investors will benefit the
most from this strategy, to whom I recommend an aggressive
allocation of U.S. and international growth-oriented stocks and/or
low-cost ETFs, index, or mutual funds.
Middle-aged investors that have a somewhat shorter time frame
before drawing assets from their portfolios should be more mindful
of their investment strategies but can still use volatility to gain an
advantage. While I recommend the same process as above, the
exception is that slightly less aggressive investment allocations
should be established. Generally, I also recommend building larger
positions in interest-earning cash, fixed-income bonds, and
dividend-paying stocks and funds.
VEERING FROM VOLATILITY
As for aging investors and retirees, be warier of renewed market
volatility. Presumably, you have less time to recover from any
market losses, so high volatility can really upset your long-term
plans. The key here is to invest more conservatively — maybe even
more conservatively than your investment risk tolerance would lead
you to believe. The same can be said for very risk-averse investors.
Ideally, commit to individual stocks or funds only the portion of
your portfolio that you’ll draw from in 10 years or more. If doing
so leaves you with little or nothing to invest in equities, then
gradually reduce the “waiting period” to use your portfolio assets
to as low as six years to maintain some exposure to equities. At
each successively shorter period — nine years, eight years, etc. —
estimate the amount of equities you can comfortably hold in your
portfolio. It’s critical at this stage in life to maintain some allocation
to individual stocks or funds to increase your odds of offsetting
rising inflation and income tax rates.
If you find that you will likely draw down funds from the portfolio
in less than six years, then rethink your spending habits. Either
reduce spending, or if possible, remain in the workforce for a longer
time to defer drawdowns from your accounts.
Late-stage career workers and retirees should also work with a
financial planner. A detailed plan can help you make better
decisions about asset allocation, portfolio design, goal setting, and
spending. At this stage, you cannot afford to make significant
As investors, we must embrace the truth that stock market volatility
rises and falls. While the current environment represents a period
of relatively higher volatility than we’ve seen in recent years, using
the tools and information available to investors today will only help
in the long term. Don’t let emotions get in the way of potential
profits. When volatility heats up, keep your cool and put your
capital to work.