How Will Market Volatility Affect Your Portfolio?

It’s not a secret that markets are often unstable and go through periods of volatility. What’s important to remember is that, while frustrating, these market ups and downs are normal and expected, although the factors that contribute to them may change. It’s also key to point out that you have options during these uncertain phases and you can take steps to protect your investments and minimize losses.

What is Market Volatility?

Simply put, volatility is a term to describe the corrective process that forces prices lower. Most investors hate volatility associated with price declines. Not surprisingly, they don’t mind it when stocks go up 300 points, but that doesn’t seem to happen as frequently as price decreases. 

When discussing market corrections, it’s crucial to place them in categories to deal with them appropriately. First, you have the type of price correction associated with the normal ebb and flow of markets. While there are always excuses for why markets decline, the usual underlying reason is that stocks are overbought, and buyers vanish until lower prices, time, or a combination of these factors, bring stocks to levels that will attract buyers. 

Historically, these sorts of corrections tend to lead to market declines of 5-20 percent. That is why the average volatility of the market is around 14 percent. We saw one of these corrections back in late November 2015 through January 2016, and another related to the “Brexit” panic in the summer. Anything more dramatic, such as a decline greater than 20 percent, usually has a stronger catalyst behind it. The types of factors that contribute to a steep decline are an unpredictable event or, more likely, a fear of economic slowdown.

These situations force investors to alter their market assessment and typically mean that market prices have to decline in order to discount whatever changes investors fear will take place.

The final category of decline is a cyclical bear market. These are rare events and are longer-term declines that force severely overvalued markets back into equilibrium.   Right now, all the evidence suggests that if we are beginning a correction, it leans more towards the average instability of stocks.

What are some factors leading to our current unsettled phase?

Current Market Situation

This summer, we experienced a period of over 40 days where stocks didn’t move even one percent. That trend seems to have changed since we turned the corner into September. On September 9^th we witnessed the markets lose a bit over two percent of their value and since then, stocks have been fitful.

As we creep closer to the November Federal elections, we will most likely see increased volatility. Here are a few reasons why this could occur:

1. Economic Weakness

The first cause of current instability is the general state of the economy. While economic indicators continue to trend toward the positive side, there have been undercurrents of weakness in certain areas all year. For example, auto sales, while still strong, have been less robust in the past few months.

2. Corporate Earnings

Also, as we march further through September, we’re going to start hearing about corporate earnings. A recent belief on Wall Street is that earnings may be starting to see positive year over year quarterly comparisons. This leads to investors anxiously awaiting third quarter numbers that will be announced  at the beginning of October.

3. Increased Interest Rates

Another factor that leads to volatility is that Wall Street will be on “Fed Watch” for a possible rate hike at their September meeting. Most investors still think that the Federal Reserve will want to wait until after the elections to raise rates, but any change to this view could bring about more uncertainty in the markets.

4. November Elections

The upcoming elections will likely become a significant headline event for stocks. We mentioned in our summer letter that investors were pricing in a Clinton Administration.  However, if investors begin to doubt this consensus, then markets could become increasingly unsettled. There are two primary ways the consensus could change: first, a poor debate performance by Mrs. Clinton, and second, voter doubts about the stability of her health.

Mrs. Clinton’s health became an issue after she suffered some sort of event at ceremonies commemorating the September 11, 2001 attacks.  Only time will tell if this becomes a bigger issue for the markets. Investors, however, are likely increasingly aware that she has more health problems than anyone previously believed.

5. Statistical Market Performance

Finally, statistically, the September-October period is typically the weakest timeframe during the year in terms of market performance. The volatility we experienced on the September 9^th serves a reminder of where we are in the calendar’s investing cycle.

Despite the volatility, you can still plan ahead and protect yourself. Here’s what we do for clients and this is what you can do for yourself in the face of such market uncertainty.

What Steps Can You Take to Deal with Volatility?

The first thing is to understand that corrections are part of the investment process.  Stocks don’t go up all the time and the day-to-day movements usually have nothing to do with longer-term market direction, either good or bad. That being said, there are actions you may need to take as you look at the ways volatility will affect your financial plan.

1. Reevaluate

Investors should review their individual risk and reward profiles to ensure they are still in line with their goals. More often than not, investors are better off staying with their longer-term investment plan. Sometimes, though, things change and you need to reevaluate.

It’s possible that something has changed in the kind of return you are expecting from your investments versus the risk you are willing to take. In that case, reexamining your portfolio now, while markets are near all-time highs, is a more strategic move than taking action after markets have lost 10-15 percent of their value. One of the ways we do this is to review client positions and attempt to size their cash exposure appropriately. Cash currently pays next to nothing, but it can sometimes be a better option than losing money.

2. Diversify

Another wise move is to diversify your portfolio across different asset classes. This method often smoothes out some market volatility, although it’s not likely to prevent your portfolio from declining when markets correct.

In a low-interest rate environment, we follow a growth plus yield strategy. We look for Exchange-Traded Funds (ETFs) that we believe have the potential to give us superior longer-term growth in client’s portfolios. 

3. Keep Calm and Hold On

Finally, understand that while this period is statistically the weakest part of the year, we are now closer to that November to April period where stocks have historically posted the majority of their gains. While there is no guarantee that this will occur each year, and it likely will not if we are headed into a slower economic environment, stocks have traditionally finished the year strong. Assuming things don’t change, a run-of-the-mill correction should be viewed opportunistically.

If you have any questions or concerns about market volatility and how it will affect your portfolio, please contact us at 708.488.0115 or by email at lumencapital@hotmail.com.

About Chris
Christopher R. English is a money manager and the founder of Lumen Capital Management, LLC, a Registered Investment Advisory firm. Specializing in investment management and developing customized portfolios that reflect a client’s values and needs, he has nearly three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 708.488.0115 or emailing lumencapital@hotmail.com.

I have to be out tomorrow so the next post here will be Wednesday.