Remaining Calm throughout the Storm: Understanding Market Volatility

By Jasen Gilbert, CFP^®

As I was returning home from a conference in Pennsylvania, I rode at the back of a bus on my way to the Philadelphia airport. On that 40-minute commute, I experienced one of the bumpiest roads of my life. With every pothole and every crack, I lurched in my seat and was thrown around like a rag doll. As I got off the bus, I was green in the face.

Bumps in the road can often be jarring and downright sickening – not only as it relates to my perilous journey on I-76, but also when we experience the ups and downs of a volatile market. As an investor, you are taken for a ride on an emotional roller coaster when the markets fluctuate – from hopeful and elated to alarmed and desolate.

The impulse to run away from the market during a correction period is totally natural and inherently human. Our fight-or-flight response – triggered by the amygdala region of the brain – causes our adrenaline to surge and sparks feelings of anxiety and distress. While this function is essential to our survival, the amygdala can also cause us undue stress when the source of our concern is largely beyond our control.

However, if we take a step back and put the immediate state of play into the broader, long-term context, we can overcome the “alarm bells” of our amygdala. Simply put, the market has always gone down and has always gone back up. Those who stay the course are often rewarded. In addition, volatile market conditions can present significant opportunities for savvy investors.

Why the Volatility?

In a deeply interconnected global economy, a wide variety of factors – both at home and abroad – are contributing to the current volatility. While a comprehensive list of factors is beyond the scope of this article, we will highlight the major current events that are driving the market fluctuations.

If you’ve been keeping up on your business news lately, you will likely be familiar with these topics. These stories have dominated the headlines.

Domestically, the adoption of tariffs has raised concerns for industries that depend on imported goods and for companies that sell their products overseas. In a similar vein, the recent revisions to NAFTA and discussions of other agreements have caused some uncertainty in the realm of international free trade.

Additionally, the Federal Reserve has continued to incrementally raise the federal funds rates (now set at 2.25%); while these rates are historically low compared to their pre-2008 levels, there has been a substantial increase since 2017 (when the rate was 0.5%). These three factors are driving much of the anxiety in the domestic sector.

In international news, the Chinese stock market has been careening downward since January. After reaching an all-time high of 3,559 on January 24, the Shanghai Stock Exchange Composite Index has fallen to 2,602 as of October 31 (a 26.8% decrease). The ripple effect of China’s economic woes can be felt worldwide.

Across the pond, the negotiations for Brexit still hang in the balance. By many indications, the divorce between the European Union and the UK could be a messy one.

In addition, Italy’s 2019 draft budget has been rejected by the EU. As seen in Greece, the massive debt incurred by Italy – coupled with the economic strain of the EU’s austerity measures – could be dire for Italy, and these factors have prompted murmurs of an Italian exit from the international alliance.

Lastly, leadership changes in Mexico (a new populist president, Enrique Peña Nieto) and in Brazil (a new far-right president, Jair Bolsonaro, who has advocated pro-market policies) could influence the investor outlook in the Latin American sector, as well as U.S. interests that are enmeshed in the region.

Without question, the global economy has never been more complicated and intertwined – and the future is sure to be filled with even more complexity. That being said, the level of volatility we are seeing today is not a new phenomenon.

Zoom Out to Bring the Full Picture into View

Despite the alarming nature of these recent financial news headlines, the reality is likely far less scary than we are inclined to believe. Let’s calm down our amygdala by putting the current situation into proper historical context!

On the graph below, you can see the annual performance data of the S&P 500 for each year since 1980. The gray bar represents the annual percentage of return; the red boxes represent intra-year declines – the difference between the highest and lowest points of the index during each particular year – as a measure of market volatility.

In 2017, the S&P 500 experienced a fairly steady market trend, where the strong upward trajectory was not offset by any significant corrections. In the first 10 months of 2018, we have seen a noticeable increase in volatility. However, the year-to-date market performance is still well within the historical norm.

With an intra-year decline of 10% in 2018, the circumstances facing the S&P 500 are far from dire and are quite comparable to the course taken by the markets in 2016. Also note that even in years where the intra-year declines were substantially larger (between 11-19%), the average calendar year return was 7.6%. For this reason, staying the course when the markets get choppy is often a wise decision.

The Greatest Opportunity

As investing legend Warren Buffett has famously said, “Be fearful when others are greedy and greedy when others are fearful.” Without a doubt, a correction period presents the potential to tap into significant financial planning opportunities:

• Buying opportunities for accumulators: If you are a career-focused professional who is actively saving money for retirement, corrections are essentially a seasonal sale on stocks. In many cases, it may behoove you to put your cash to work when the market takes a dip.

• Tax loss harvesting: You may want to consider selling some positions that have lost market value. By “harvesting” this loss, you can leverage the decrease in value to offset taxes on both capital gains and income. Tax loss harvesting can be an effective way to remove struggling stocks from your portfolio while also reducing your tax burden.

• Rebalancing: In some cases, it may be beneficial to revisit your asset allocation and identify areas for enhancement. The recent losses and volatility are not evenly distributed among asset classes; some sectors are performing well or holding steady, whereas others are lagging. Rebalancing allows you to reinvest the profits from an outperforming stock or industry into a different asset class that could have greater growth potential, while also maintaining a diversified portfolio to hedge against risk.

If the bumps in the road we have been experiencing in the market are causing your stomach to churn, you are not alone. You are human! We are hard-wired to react emotionally when the market slides. The often-sensationalized media coverage of current events and financial news also fuels the fear response and apprehension about staying in the market.

However, when we look at the big picture of market performance over the long haul, we find that – in many cases – the most prudent course of action is to (1) stay the course and (2) capitalize on any untapped opportunities that may arise as a result of the correction.

Fortunately, your CAS advisor is always available to help you look past the fear and anxiety, bring the big picture into focus, and explore the possibilities for maximizing your upside as we weather the turbulent tides of volatility.