Market Update - The return of volatility

First, a review

Markets were moody during the first quarter of 2018 – sizzling to record levels in January, correcting in February and then continuing to decline in March.  The first quarter saw a lot of activity, including the signing of the Tax Cuts and Jobs Act, fears of inflation rising unabated and more rate hikes from the Fed, a potential trade war between the U.S. and China and an about-face from the red hot, tech stocks.

The Dow Jones Industrial Average fared the worst of the major U.S. market indices, losing 2.5% over the quarter and ending its streak of nine quarterly gains, which happens to be the longest streak since the 11-quarter rally that ended in the third quarter of 1997.

The S&P 500 was down 1.2% for the first quarter and it too ended its nine-quarter streak. This was the first quarterly loss for the S&P 500 since 2015.

NASDAQ, on the other hand, was up 2.3% for the quarter, which is its seventh straight quarterly gain.

Sizzling January, Correction in February and Losses in March

January got off to a sizzling start, with the DJIA, S&P 500 and NASDAQ leaping by 5.8%, 5.6% and 7.4%, respectively.  And many market experts attribute the sizzle to a fantastic fourth-quarter earnings season and the passing of the Tax Cuts and Jobs Act of 2017.  For backdrop, consider this from research firm FactSet:

• 77% of S&P 500 companies exceeded sales estimates
• The S&P 500 reported revenue growth of 8.2% for the fourth quarter – the highest growth since the fourth quarter of 2011

Then February ushered in unanticipated corrections (meaning declines of more than 10%) of the key indexes from their all-time highs achieved on January 26th.  An end of month rally improved the numbers somewhat, but February ended with the DJIA, the S&P 500 and NASDAQ declining 4.3%, 3.9% and 1.9%, respectively.

The March data is in the table below.

The Return of Volatility

We went into the beginning of 2018 knowing that the previous year brought us the lowest levels of volatility in decades – in fact, the market’s so-called fear index, the VIX, hit an all-time low in November of 2017.  But by the time we reached the end of the first quarter in 2018, the VIX had increased a whopping 81%! (See the chart at the top of this post) 

Let’s look at volatility another way: in the first quarter of 2018, the S&P 500 had 12 days where it was up over 1% and 11 days where it was down at least 1%. In 2017, there were only 4 such days!  In the first quarter of 2018, looking at days where the market moved 2% or more, we see that there was only 1 day where the market moved up more than 2% and 5 days where the market moved down more than 2%. In 2017, there were no 2% moves either way!

Although volatility has returned in 2018, when analyzing the volatility of the stock market, 2017 is actually the unusual year. This may be attributed to the ongoing bull market, positive earnings, positive news flows, and overall investor complacency.

We usually see 3 – 5 pullbacks of 5% or more per year.  In the chart below, according to JP Morgan Asset Management, on average we have an intra-year drop of -13.8%.  The gray bars in the chart are the returns for the year and the red dots are the maximum decline during the year.  Notice that there are very few years with less volatility than 2017.

What should an investor do?

For most investors, the best thing to do is “stay the course” and focus on the long term.  We understand that market volatility can play with your emotions, but as explained earlier, volatility is a natural part of investing.  If market fluctuations are making you question your portfolio then maybe it’s time to sit down and do a review.  Some things to consider are:

• Do you have a plan? – Every portfolio should start with a financial plan and an investment plan to match.  If you have a plan, have your goals changed since you started investing?  Having an updated plan makes it much easier to determine the amount of portfolio risk needed to achieve your goals. It also helps to remove the emotions from investing and to rely more on a disciplined, rules-based, approach.
• Asset allocation and rebalancing – In recent years, with the run up in equities, have you rebalanced regularly?  If not, your portfolio is likely out of balance and over-weighted in equities?  This always feels good on the way up, but can be extremely painful in volatile and down markets.
• Diversification – Do you have a globally diversified portfolio with many different types of investments?  This is one of the biggest contributors in reducing a portfolio’s volatility.

What to do next?

• Review your individual risk tolerance - You can get started yourself by clicking here.  Once completed, we’ll help you review your portfolio and determine if it is properly aligned with your personal preference for risk.  If you prefer, you can give us a call, or click below to schedule a meeting.
• Schedule a review - Whether you are a current client or not, we are always happy to be another “set of eyes” to analyze your portfolio and discuss strategies for weathering market volatility.
  
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