How to navigate through market volatility
08 February 2018 | Markets and economy
Global equity markets have experienced several volatile trading days recently. Vanguard believes this reflects concern over abnormally high market valuations, continuing central-bank monetary policy normalisation and the prospect for rising inflation.
Although the volatility caught many investors by surprise – leading to inevitable questions about whether one of the longest-running bull markets in history is ending – it's consistent with the cautious assessment set out in our 2018 market and economic outlook paper, Rising risks to the status quo.
It's important to remember that corrections and bear markets are not unusual. Research by Vanguard's Investment Strategy Group shows that since 1980, globally significant market events such as corrections or bear markets have happened about every two years. The typical investor will have to endure many such events over his or her lifetime.
Market downturns aren't rare
Source: Vanguard analysis based on the MSCI World Index from 1 January 1980 through 31 December 1987, and the MSCI AC World Index thereafter. Both indexes are denominated in US dollars. Our count of corrections excludes those that turned into bear markets. We count corrections that occurred after a bear market has recovered from its trough even if stock prices haven't yet reached their previous peak.
It's also important to put volatility into historical context. Market uncertainty can cause investors to diverge from their asset allocation plans as they try to insulate themselves against turmoil. But trying to time these events can lead to costly mistakes. In many cases, timing the market for re-entry simply results in selling low and buying high.
Many downturns barely register when taking a long-term perspective
Note: Intraday volatility is calculated as daily range of trading prices [(high – low) / opening price] for the S&P 500 Index. Sources: Vanguard calculations, using data from Yahoo! Finance.
Indeed, the markets' best and worst trading days have often happened close together. In fact, the worst trading days actually happened in years with positive performance.
The markets' worst days and best days are often close together
What's causing the volatility?
As outlined in our 2018 market and economic outlook paper, Vanguard believes the increasing synchronisation of growth rates across major economies is setting the stage for central banks in the United States, Europe and elsewhere to begin rolling back some of the extraordinary policy measures enacted in the wake of the global financial crisis. The chance of economic jolts resulting from a return to "normal" monetary policy is high, though our research leads us to believe that long-term market volatility is less likely.
In addition, improving economic conditions have led to tighter labour markets. With 80% of major economies already at full employment, we expect jobless numbers to decline further in 2018, to multi-decade lows. Rising wages could result in higher inflation and, in turn, a faster pace of short-term interest rate increases by central banks.
What should investors do?
Vanguard believes investors should focus on what they can control and consider these simple principles before making drastic portfolio moves.
- Stay diversified: A great way to insulate your portfolio is to have exposures to equities, bonds and international markets in an asset allocation plan that makes sense for your age. Bonds can act as a ballast during downturns. International exposure can provide access to markets that may be generating positive performance when others are falling.
- Tune out the noise: There's an old adage of never checking your retirement account when stocks are tanking. It's smart advice. Making decisions based on a recent market event often results in mistakes.
- Pay attention to costs: Investment expenses eat into your returns. This is a particularly painful realisation when stock markets are correcting.
- Revisit your asset allocation: If market corrections are making you lose sleep it may be time to reevaluate your risk tolerance.
- Set realistic expectations: Vanguard's Investment Strategy Group is anticipating higher risks and lower returns over the near and medium term.
Above all, we believe investors should see the big picture, focusing on the progress of their portfolios over time – not the daily ups and downs.
“What's in the headlines right now may make it feel difficult, at times, to stay the course,” said Donald Bennyhoff of Vanguard's Investment Strategy Group. “But keep in mind that, although the headlines have changed, it's likely that your investment objectives haven't.”
For investors who need additional reassurance, professional guidance can be particularly important.
“Investing is hard. It's emotional. You have a lot at stake,” Mr Bennyhoff said. “Getting a more objective perspective from someone who's at arm's length from your portfolio can help you make more rational decisions.”