Triggers for market volatility have historically taken several broad forms, including changes in growth and inflation expectations, policy uncertainty in Washington, geopolitical risks, and quarterly earnings announcements. The market turmoil we are experiencing today is primarily driven by three major factors – trade tensions, Fed policy, and earnings forecasts. (See Peloton’s July newsletter as we discussed in detail our market outlook and views on these important factors.) The bottom line is that Washington policymakers, both politicians and FOMC members, have dug in their heels and markets have responded.
So how should investors respond? This is an important question and depends considerably on each individual’s time-horizon, risk tolerance, and objectives. However, one thing is certain: long-term investors should not overreact to short-term volatility. When volatility rattles markets, a proven volatility playbook can serve as a helpful resource for investors who want to avoid making emotionally-charged mistakes:
Keep Perspective – Market pullbacks have always been followed by recoveries – eventually. Since 1980, intra-year stock market declines have averaged 14%. Yet in 29 out of the past 39 calendar years (or approximately 75% of the time) stocks recovered by year-end and posted full-year gains. Sometimes the recovery takes longer, but in every instance stocks have rebounded and reached new highs. Bottom line – history is heavily on the side of those who do not overreact to market corrections.
Tax Planning – Opportunities do exist for tax-savvy investors. Tax-loss harvesting (realizing losses to offset capital gains), and Roth conversions (converting money from a traditional IRA or 401(k) to a Roth account), are two highly effective tactical strategies to implement when markets correct. Bottom line – combining sound tax and investment strategy can significantly enhance financial outcomes.
Investment Strategy – Opportunities also exist for smart investors who understand volatility is simply a reality of investing. Downturns are normal and normally short lived. Dollar-cost-averaging (making systematic investments over time) is a prudent investment strategy to reduce the impact of volatility on large purchases of financial assets. Additionally, periodically rebalancing your portfolio is a powerful tool for managing risk. Finally, let’s not forget cash is king and having some dry powder on hand can also provide investors with an advantage over others during market dislocations. Bottom line – a disciplined investment approach can help investors take advantage of market volatility.
Stay the course – Timing markets is difficult and can be very costly. Investors are often best served by simply staying the course through short-term fluctuations. The natural urge to act when markets turn down often leads to emotional trading mistakes. Often doing nothing is the best strategy. Investors who periodically revisit their personalized investing plan are better prepared for the normal ups and downs in the market. Bottom line – downturns happen frequently, and prudent investors don’t let short term volatility undermine sound long term strategies.
As the economic cycle matures, and as the political cycle ramps up again, Peloton Capital Management believes market volatility is here to stay. Having a firm understanding of your investment strategy and a volatility playbook to lean on will help you weather future storms and capitalize on opportunities.