Volatility is back. The benchmark S&P 500® slid more than 4% on Monday, February 5, adding to its losses from the week prior and giving back its gains for the year.1 The Dow Jones Industrial Average lost 4.6% in a 1,175-point rout (it was down nearly 1,600 during one 15-minute stretch). Following the Dow’s 666-point tumble on Friday, February 2,2 and sell-offs in Asia and Europe, it figured to be a wild ride in US trading on Monday. And wild it was.
But just as quickly as the market can trend down, it can swing back up. Stocks bounced back on Tuesday, February 6 with gains in a roller coaster session. The Dow swung more than 1,100 points on the day before closing up 2.33%. The S&P finished in positive territory as well, gaining 1.74%.3
Market observers are pointing to several culprits for this spike in volatility:
- Potential inflation. The economy is accelerating, evidenced by strong jobs data that reflected rising wages. Should inflation rise from stubborn lows, some investors may see heightened risk of the Federal Reserve raising rates faster than signaled.
- Rising rates. Higher interest rates mean it’s more expensive for companies to borrow, which can reduce the attractiveness of their stocks. Longer term, some fear that a more hawkish Fed and tighter monetary policy could hamstring economic growth.
- Treasury yields. Historically low volatility, easy monetary policies, and government bond yields encouraged investors to seek greater returns (and risks) from stocks. However, Treasury yields have been rising, potentially giving investors safer alternatives than stocks.
- Stretched valuations. It’s been record after record for stocks for more than a year and it appears valuations may have grown to levels that encouraged profit taking.
Combined, these factors have upended the low-volatility, record-high market narrative that had been in place for quite a long time—some would say too long. For investors looking for answers, let’s check in with Mike Loewengart, Vice President of Investment Strategy at E*TRADE Financial.
How should investors view this volatility?
Context helps. It was inevitable that volatility would increase and that a sell-off would occur at some time. Market volatility was extremely low from late 2016 through 2017. The largest peak-to-trough decline in the S&P during that period was roughly 3%. That is highly unusual, considering that the average calendar year drawdown over the last three decades is in excess of 10%.4
Are there recessionary signs?
Not according to the fundamentals. Remember, the stock market isn’t the economy. Global growth is strong and appears to be accelerating. Economic conditions across numerous indicators are solid, including labor market data. Interest rates are still well below historical levels and the Fed continues to signal it will continue to raise rates slowly. On the corporate side, earnings are projected to rise, benefitting from lower taxes and repatriation incentives in the new tax code.
What's important to remember right now?
Pullbacks and corrections aren’t all bad and are a normal part of the investing experience. That’s particularly true for investors who have already diversified their portfolio with a mixture of assets to handle the market’s ebbs and flows. Rather than fearing a downturn, consider embracing it. There may be bargains out there, especially for those patient enough to hold them until a potential rebound.
Should investors try to time the market?
It’s extremely difficult. For anyone on edge over these recent moves, timing the markets is a futile exercise. Not only do investors need to sell at the correct time, but they also need to buy back in at the correct time or risk missing out on a rebound.
How can a downturn be a good lesson?
Investors should control what they can control. And while investors can’t control the market, they can control how they participate in the market. Two simple steps that every investor can take to help mitigate their exposure to a downturn are the following:
- Review risk tolerance. Regularly defining how much risk an investor is able to stomach will likely help keep market swings in perspective.
- Balance risk/reward with asset allocation. A broad mix of stocks, including foreign equities and bonds, across the maturity spectrum can help navigate investors through upticks in market volatility.
The bottom line
Wanting to act after a sharp market downturn is understandable. But history shows that investors can be rewarded by staying the course and sticking to a well-defined strategy that reflects their long-term goals, time-line, and risk tolerance.
1. Krauskopf, Lewis. “Wall Street plunges, S&P 500 erases 2018’s gains,” Reuters, 5 Feb. 2018. https://www.reuters.com/article/us-usa-stocks/wall-street-plunges-sp-500-erases-2018s-gains-idUSKBN1FP1OR
2. Culp, Stephen. “Dow sees worst day in two years as bond yields jump,” Reuters, 2 Feb. 2018. https://www.reuters.com/article/us-usa-stocks/dow-sees-worst-day-in-two-years-as-bond-yields-jump-idUSKBN1FM1KC
3. Krauskopf, Lewis. “Wall Street roars back in whipsaw session,” Reuters, 6 Feb. 2018. https://www.reuters.com/article/us-usa-stocks/wall-street-roars-back-in-whipsaw-session-idUSKBN1FQ1OZ
4. “Guide to the Markets®, U.S. | 1Q 2018| As of December 31, 2017,” page 12, JPMorgan Asset Management. https://am.jpmorgan.com/gi/getdoc/1383518167130
The S&P 500® is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the US stock market.
The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 companies and then dividing that total by an adjusted value—one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities.
The Chicago Board Options Exchange (CBOE) Volatility Index®, also called the "fear index," is calculated by CBOE and measures expected volatility of the US market in the next 30 days. The higher the number, the more bearish the market is in general.