October 2015 Monthly Insight: Volatility is a Natural Part of the Market

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on Oct 15, 2015


Last month’s letter talked about preparing yourself for major market moves, especially downward moves, by conducting “lifeboat drills” in order to dampen your “startle response”, which might result in an inappropriate decision that would derail your long-term investment goals and objectives. During the month of September, investor anxiety continued to spread as uncertainty around the future of interest rates continued to drag down markets.  For the month of September, the market was down for the month, down year-to-date, and down for the past 52 weeks. There were 21 trading days in September of which 11 were down. Of those 11 days, six were down greater than 1%, and there were ten up days with four days up greater than 1%.  Also, seven of the last ten trading days were down.  Thus market volatility continued.

A jarring market correction may create uneasiness, as some of you have shared with us.  We can’t help but be reminded of a comment by John Bogle, retired CEO and founder of the mutual fund giant, The Vanguard Group.  Bogle said, “Don’t pay a lot of attention to the volatility in the market place”.  All these noises and jumping up and down along the way are really just emotions that confuse you.”  But, experiencing your feeling of uneasiness is an appropriate response.  However, the question shouldn’t be, “Will my investments go up or down?”  They will.  Instead, ask, “Will the fact that investments go up and down bother me enough to do something I will regret later?”  In other words, Bogle is saying that volatility is part of the DNA of the market.  Stocks go up, and stocks go down.  Historically, stocks have gone up a lot more than they have gone down.  But from time to time, they do go down.

Stock market corrections, defined as a decline of 10% to 20% of a major market index – typically the S&P 500 Index – are a normal part of the investment landscape.  In the context of an expanding economy, they are healthy when valuations get a bit extended, as they wipe out excess enthusiasm, reduce valuations, and set the foundation for another round of gains.  That sounds a bit clinical and we know recent volatility has been unsettling.  Nevertheless swings in the market are normal.

But, let’s be clear: Volatility can be managed by investing in a diversified portfolio that seeks out long-term capital appreciation, a modest degree of stability, and income.  Since the May 21, 2015, peak in the S&P 500 Index, shares are down 9.89% at the end of September, theoretically, but just, out of the correction zone.  Prior to May, the market had been on a six year run.  It had been four years since shares have lost more than 10%, which is an unusually long time.  Such instances may lull an investor into complacency, which adds to the angst when shares fall.  Historically, however, 10% declines are more common.  As we discussed in previous newsletters.

Fed’s Surprise Decision, For Now

The Federal Reserve’s decision earlier this month to keep interest rates unchanged caught many market “seers” and pundits by surprise. In her press conference after the latest Fed meeting, Fed chair Janet Yellen said interest rates could increase only if inflation rises from current levels.  She also mentioned “global economic and financial developments” were restricting the Fed.  The Fed is now basing its decision to raise interest rates on data and not the calendar, which is proper policy.

The Fed has a dual mandate to keep both inflation low and employment high.  Unfortunately, policies to help reach full employment may lead to higher inflation.  So, the Fed must walk a tightrope on when it raises interest rates in order to not harm the economy.  The Fed’s press release after the September meeting said, “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”  Further, the press release said that even if employment and inflation approached their mandated levels, economic conditions may warrant keeping the funds rate below normal levels.

What the market is really seeking from the Fed is guidance on its intentions with respect to raising interest rates.  The market hates uncertainty, and expecting a rate increase in September and not getting one sent shivers through the market.  More recently, however, Ms. Yellen has been more forthcoming in her guidance, sort of.  Last week in a speech at the University of Massachusetts, she seemed to subdue some uncertainty about the economy by saying that she expects the Fed to raise interest rates “sometime later this year.”  Of course, she qualified the prediction saying the Fed would continue to rely on economic data in informing any future decisions.  The Fed has two meetings remaining this year, October and December.

The Bottom Line

If you are a number of years from retirement, a drop in the market may provide an opportunity to selectively deploy any excess cash.  If you are nearing retirement, your portfolio is adjusted for risk, so it is designed to be less volatile in both up and down markets.

As we’ve said before, the financial plan we’ve recommended incorporates market declines and is a financial roadmap that’s tailored to your financial goals.  We don’t know when we’ll run into traffic jams or hit a pothole, but we believe that detours or deviations from the plan will hinder not help your progress.

But now may also be the time for a self-evaluation.  If this selloff has created anxious evenings, we need to revisit.  For some, it’s easy to express a high degree of tolerance to risk when markets are rising.  We understand the swift correction may be disconcerting for some and irresponsible headlines in the media only add to concerns.  But markets will correct from time to time.  Eventually, we may get a bear market, or a 20% decline.  It will happen and few, if any, will call it in advance.

We always emphasize that as your financial advisor, it is our job to partner with you.  If you ever have any questions about what we’ve conveyed in the monthly message or want to discuss anything else, please feel free to reach out to us.

We are humbled that you have placed your trust in our firm and we thank you for that.  Your trust is something we never take for granted.