With the various national and global factors during 2016 playing an influential role in stock market performance, many investors and advisors are grappling with the fluctuations in market volatility.
There are many unknowns and uncertainties at play when it comes to volatility, heightening the instability investors face. Because the average investor doesn’t understand volatility and the effects it can have on a portfolio, they rely on sources like the CBOE Volatility Index (VIX) or market pundits for information on the performance of the marketplace. It’s the influence of these sources, however, that exacerbates the up-and-down swings investors see.
Every day, investors tune into the news or read headlines that ultimately guide their actions. Seeing this constant coverage of different catalysts, such as the recent British referendum, the upcoming presidential election, oil prices and other geo-political risks, influences market volatility from a reactionary perspective. Investors start to internalize what they perceive to be happening in the marketplace, and it results in responses that are predominantly emotional rather than logical. These news story reactions, called headline risks, ultimately play a role in shifting market performance.
This phenomenon becomes a self-fulfilling prophecy. Investors rely on others to tell them how the market is performing – they feel more comfortable when things are reported as going up, so there is no fear in their holdings, and they continue to happily buy and invest. However, if they see that their investment value could drop, they often make rash decisions that result in them selling at the worst times for their long-term plans.
Inevitably what transpires is, when the market begins to recover, investors have to go through the process of second-guessing their investment strategy again. They consider how long they should wait to get back in the market, and usually won’t even return until it is up 6 or 7 percent. While they’ll feel better about how the market is behaving when they decide to invest again, these individuals have lost some momentum in the market and will likely have to deal with sideways drift or increasing volatility that results in a reversal of the gains they thought they were going to see.
To combat this occurrence, it’s important for investors to understand what they own and the impact of those holdings within the market. Investors need to be positioned in a way where they own higher quality, lower volatile stocks that have a history of earnings and lower amounts of debt. By focusing on a lower risk approach to investing, when there are sustained periods of volatility in the market this year – similar to what we are currently facing – investors should not be as susceptible to the markets’ loss.
Although investors are dealing with volatility right now, the threat of higher risk itself won’t be a withstanding factor. In fact, with historically low volatility over the last three to four years, we expect longer periods of lower volatility than high.
As 2016 progresses, the events or headlines that will continue to occur shouldn’t take the market off course or damage the U.S. economy. While there will always be catalysts that create volatility, such as a possible recession, oil price fluctuations, a strong dollar, etc., none of them should continue for a long enough period of time to cause a sustained volatile market with huge fluctuations.
Although the natural tendency is to react emotionally when dealing with investing money, savings and retirement, it is important to remember that these headline risks aren’t entirely indicative of long-term performance. Just because someone says that Brexit will stress the markets now, it does not necessarily mean that stocks should be sold. Investors need to consider this moving forward and resist reacting to these triggering market events that are not truly impacting the long term strength of their holdings.
Bryce Sutton is managing partner and co-founder of Summit Global Investments, LLC, an SEC registered investment adviser specializing in low volatility investment strategies. Learn more at www.summitglobalinvestments.com.