Volatility is here to stay: What you can do about it
January 15, 2016
Financial markets are off to a bumpy start in 2016 as fresh signs of China’s economic slowdown and a slump in oil prices spark investor concerns over whether the recent turbulence is just heating up.
"We’ve been preparing investors for the return of volatility for some time," said Tim Buckley, chief investment officer at Vanguard. "We just came off a long stretch of remarkably tame markets, so the sudden surge in volatility is going to feel worse than it actually is."
Volatility makes a comeback
Since the bottom of the financial crisis in 2009, markets have staged one of the strongest recoveries in history. What makes the last few years particularly unique is the remarkably smooth and uninterrupted ride up.
But periods of low volatility—like high volatility—don't last forever.
Whether the catalyst is bad news out of China, a slump in oil prices, or speculation over monetary policy, the sudden spike in volatility, while unnerving, is in line with long-term historic ranges and was largely expected.
So where are we now?
Today, uncertainty remains. There are risks as China's policymakers attempt to pull off a delicate balancing act of engineering a soft landing without undermining their long-term goal to transition to a domestic consumption- and service-based economy. Beyond China, the plunge in commodity prices, the Federal Reserve’s monetary policy, geopolitical risks, and the age of the current bull market remain noteworthy question marks.
According to Vanguard's economic and investment outlook for 2016, the high-growth "Goldilocks" era enjoyed by many emerging markets through the past two decades is over. From 1990 through 2007, China expanded at an astonishing average annual rate of 10%. In less than two decades, the value of Chinese economic output more than quintupled.
As China pulls back on the investments that drove the country’s rapid industrialization and heady double-digit growth rates of the past, the slowdown in growth is going to be uneven.
So what can investors expect?
Without a crystal ball, no one truly knows. However, one thing we do know is that periods of high volatility aren’t permanent. As China’s economic transformation works its way across emerging-market economies and the rest of the globe, occasional "growth scares" and pronounced market reaction are in the cards.
Early this year, Chinese stock prices lost about 7% of their value, which resulted in "circuit breaker" trading suspensions for the day. A catalyst was a decline in the government's monthly index of manufacturing activity. The decline, while consistent with broader economic expectations, nevertheless rattled jumpy investors.
What you can do
The good news is that investors can prepare for volatility.
"The best thing investors can do is tune out the noise, and invest according to their long-term goals, not on what’s happening in financial markets," said Mr. Buckley.
While it's hard to ignore bold headlines in our 24/7 news cycle, reacting to market events can do more harm than good. Investors who maintain a proper allocation to low-cost, diversified stock and bond investments are better equipped to weather periods of high volatility.
“Save yourself the stress, and anchor your investment goals and decisions in a well-diversified long-term plan that you can stick with through all market conditions,” says Mr. Buckley. “History has shown the market rewards discipline and patience over the long run.”
- All investing is subject to risk, including possible loss of principal.
- Investments in bonds are subject to interest rate, credit, and inflation risk.
- Diversification does not ensure a profit or protect against a loss.
- Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.
- Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.