Volatility Happens, No Need to Panic
Global economic slowdown. The Ebola outbreak. ISIS.
Take your pick. Each has been cited individually and collaboratively as drivers of the recent volatility in stock markets that in recent weeks has generated the biggest price swings since 2011. Consider that Wednesday marked the 18th straight day the Dow Jones Industrial Average swung more than 100 points from its session high to the session low.
Tuesday marked the third straight late-day rout in which markets attempted for much of the day to push higher only to succumb to the pressure of relentless Ebola headlines and less-than-stellar third-quarter earnings reports.
Meanwhile, the CBOE’s VIX Index, known as Wall Street’s fear gauge, touched 26 earlier today, the highest level for the market’s fear barometer since December 2011. And yields on U.S. Treasuries are tumbling as investors flock to the safety of U.S. government-issued debt.
The question is why?
David Kelly, chief global strategist at J.P. Morgan Funds, noted that “nothing happened last week to justify a sudden surge in volatility. In fact, from a market-moving event perspective, it was a very quiet week with no major economic releases and just a handful of U.S. corporate earnings reports.”
Volatility Happens
Sometimes volatility just happens. Like now. So it’s probably as good a time as any to remind investors that volatility comes with the territory. It needn’t be feared and, in fact, can be worked to your advantage.
“Make volatility your friend rather than your enemy,” said Scott Clemons, chief investment strategist for private banking at Brown Brothers Harriman.
Clemons said the recent reversal of fortune in stock prices, which has seen the Dow erase all of its 2014 gains, is more “a reflection of the internal structure of markets” rather than a response to “external developments.”
Likening the stock markets’ recent lengthy upward trajectory to building a large pile of sand one grain at a time, Clemons said eventually one grain “indistinguishable from all of the other grains” will cause the pile to shift. That’s what’s happening now.
In other words, the surge in market volatility hasn’t been caused by the threat of slowing growth in China or fears that Europe is about to fall into another recession. And it isn’t a result of the media’s saturation coverage of the deadly Ebola outbreak reaching American shores. Nor can it be blamed on the surprising efficiency of the Islamist militant group ISIS. In fact, it’s all of the above and none of the above.
Markets have risen virtually uninterrupted for several years – at least since 2011 -- leaving stocks potentially over-priced and valuations inflated in many cases. Volatility had all but disappeared from the investing landscape.
Then towards the end of summer Federal Reserve policy makers began making it clear they are ready to start raising interest rates, probably in mid-2015, a move that could have a genuine impact on corporate earnings and ultimately stock markets. Factor into that the simultaneous rise of ISIS, the Ebola outbreak and recent concerns for global growth – what Clemons describes as “external developments” -- and investors have suddenly grown skittish.
Whether any of those concerns are warranted or not is really irrelevant.
Clemons said he’s hard pressed to differentiate any of the recent “external” news events from other scary headlines that emerged during the past three-year market run up in terms of their negative impact on the markets. It’s just that the mood among investors has shifted and, like it or not, investing is frequently driven by emotions rather than any rational decision making process.
“If something even a little bad happens it can lead to an exaggerated market reaction, and I think that’s what we’ve seen,” said Clemons.
Don’t Panic
Market experts are urging investors to shake off their temporary fears and take the longer view, focusing on stocks with solid histories and strong potential for growth.
Analysts at Wells Fargo Advisors urged clients not to overreact in a note distributed this week: “If you own stock in companies that you know and understand with products and services that are in demand and are likely to stay in demand in the future, then short-term stock market volatility should not deter you from participating in the company’s long-term growth potential.”
So instead of wringing your hands over scary headlines and monitoring the movements of the Dow, the Nasdaq and the S&P 500 like so many horse races, the trick is to take advantage of the large, mob-inspired swings to look for potential bargains.
Clemons said clients at Brown Brothers Harriman are being advised to do just that by increasing the amount of cash in their portfolios to 15%-20% to give them more options and flexibility should they choose to buy into a dip in a particular stock that may have been undervalued during a broader market selloff.
“It’s not about Ebola and it’s not about the midterm elections,” Clemons explained. “It’s about a company’s earnings. Don’t focus on day-to-day market volatility, but rather on the long-term value of the company.”