Why volatility is good news for investors

August was a brutal month in equities. As is typical in sudden downturns, there was nowhere to hide as correlations all moved toward one.

In other words, everything went down together.

Most indices were down as of the end of August.

Flashback

This August reminded me of August of 2011, when the markets also experienced extraordinary volatility.

In the six trading days from August 4 through August 11 of 2011, the Dow Jones Industrial Average closed up or down more than 400 points (4%) five times.

Likewise, the S&P 500 closed up or down over 50 points (3.9%) five times, and overall the S&P 500 shed 5.5% in that stretch.

My point is that volatility is a necessary and healthy part of long-term investing and by itself isn’t a reason to change strategy.

US Economy

The recent GDP report was solid, with second quarter growth revised up to 3.7%.

The report was strong across the board, with particular strength in housing, followed by cap-ex shipments, hours worked, industrial production and consumer spending.

As far as the US goes, the economy continues to expand steadily. Corporate earnings, even with a decline in energy profits, rose in Q2.

I don’t see a bubble (like tech in 2000) or systemic risk (the financial crisis in 2008).

The Fed

My opinion remains that we are in a much needed and ultimately healthy correction, which is coming during a traditionally slow period typically characterized by lighter volumes and an absence of corporate news such as earnings or conferences.

My guess would be that the market will retest recent lows (down about 6% from month-end prices) and could even take them out.

However, there’s no way of pinpointing the timing of that, and until the Fed is out of the way, I think markets will remain choppy and volatile.

Perspective

Here are some points to keep in mind, courtesy of some recent analysis by David Rosenberg of Gluskin Sheff.

There is a subscription pay wall on his research, so here’s a summary.

So far this is an orderly correction with no panic in bond yields or the US dollar
Bear markets need recessions and all signs suggest the US expansion is in mid cycle
The typical correction is 14% from the nearby high about 4% below today’s start
Corrections typically take place every 18 months, and we’ve gone 70 months without one this time – the third longest time period on record without a correction
Housing activity is at eight-year highs, auto sales at 10-year highs, jobless claims at 25-year lows and ca-pex orders are swinging up.
We just saw an 11.3% surge in mortgage applications in the week ended August 28 – the seventh increase in a row
The refinancing index jumped 16.8% and this is cash flow in consumer pocketbooks (along with extended gas price relief)
The real estate market is drum tight, affordability at great levels, household formation running below housing starts, and banks are making closed-end loans again
Some of the steepest corrections historically actually happened when the macro picture was the strongest, believe it or not – which is why they don’t morph into bear markets
The Fed is either “one and done” or “two and through” – either way, no bull market ever ended after the first rate hike

Photo Credit: Ishtaure Dawn via Flickr Creative Commons //

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