Spooked by Volatility? Here's How to Protect Your Investments:
October 23, 2018
By Michelle Holmes, CFA
Trust Investment Officer
October often ushers in a change in weather and vibrant fall colors. This year it also brought wider market value swings in the stock market. So far this month, we've seen a 52-week high in the Dow Industrial Jones Index, more than an 800-point single-day drop in the market, and a 500-point market uptick a few days later.
Is all of this market volatility normal?
The short answer is yes. Market volatility tends to run the highest during the month of October. The chart below shows the S&P 500 Index experienced the most market value changes of at least one percent in the last fifty-seven years during the month of October.
Why This month feels more volatile than the past:
The markets experienced historically low volatility in 2017. The S&P 500 only experienced a handful of trading days one percent or greater. In comparison, a more normal market environment feels much more volatile.
Why Was volatility So Low in 2017?
Low interest rates were one of the main reasons market volatility was low in 2017. The Federal Reserve Open Market Committee (FOMC) is in charge of short-term interest rates. When the economy goes into a recession, the FOMC responds by lowering short-term interest rates as it did in 2007 and 2008 during the financial crisis. The FOMC left rates near zero until 2015.
The strategy behind the FOMC is ultimately to get the U.S. consumer to spend more money. The FOMC cannot make consumers spend money so you often hear the term the Fed is “pushing on a string.” When the economy falls into a recession, the FOMC lowers short-term interest rates to make bonds unattractive so more people buy stocks. The more people who purchase stocks, the higher the stock market goes. When the stock market goes up, we fill richer and when we feel richer, we do what? Spend more money. Consumer spending is still the largest driver of the U.S. economy, so getting people to spend more money increases economic activity and thus pulls the economy out of a recession.
Stock market volatility tends to be lower when the FOMC is being “accommodative” by keeping rates low, because more cash is flowing into the stock market pushing stock prices higher. As the economy gains strength, the FOMC no longer has to be accommodative; it can start raising short-term interest rates. Once bond interest rates get high enough to compete with the yield on the stock market, you tend to see some investors rotate back into bonds. There is less certainty that the stock market will go up. This leads to more volatility as market participants have to rely on economic, global and political news instead of relying on the FOMC keeping rates low.
How To protect your investments in volatile markets
There are many ways to protect investment from higher volatility. One of the simplest and yet affective ways is to diversify your holdings. A blended portfolio of stocks and bonds provides less volatility than investing in either the stock or the bond market alone. The chart below shows that a blended portfolio of stocks and bonds does not have a negative rolling five, ten or twenty year period over the last fifty plus years.
At Security National Bank, we diversify client portfolios and work with them to find the combination of stocks and bonds to best meet their long-term goals. Are your investments outside of Security National Bank diversified? Contact an advisor today, for a free review of your outside investments.