Page 7 - NC Triangle Vol 7 No 2

PATRICK H. YANKE, CFP | Financial
Volatility Returns to the Markets
2018saw volatil- ity return to the markets ... and it made for a wild ride. Inves- tors who had gotten comfortable in the low-volatility environment of the previous nine years felt it most acute- ly. We experienced the single great- est point drop in history at the end of January! e fourth quarter was the third worst quarter since WWII! December was the worst month since WWII! e good news is that the S&P 500 was only down 4.4% by the end of
the year despite those milestones.
VOLATILITY IS THE NEW NORMAL
What changed last year to bring volatility back to the markets? Cer- tainly, we can look to macroeconomic factors in ongoing trade talks with China, recession fears, political un- certainty, energy supplies relative to demand, acts of God, and the ever- present threat of military con icts. In response to each of these, we can ad- just our asset allocation to minimize the impact to our risk assets (equities for most of us).
ere is a bigger picture, though, that goes beyond asset allocation strategies. We should be concerned with how our money is invested with- in asset classes. e relatively quiet markets of the last decade made pas- sive investing (matching market indi- ces) look better than active manage- ment (through professional money managers). e tide is changing.
Since the Fiscal Crisis, the Fed has kept interest rates near zero and has also been the greatest buyer of gov- ernment debt. is combination fu- eled liquidity in the economy. is environment was purposeful to keep calm in the nancial markets. e en- vironment is di erent now.
e Fed Funds rate is nearly 3% and they have been trying to reduce their balance sheet—being the great- est buyer of government debt in the
world ballooned their balance sheet from its traditional level of about $750 billion to nearly $5 trillion! Al- though they are pausing their recent strategy of interest rate hikes and bal- ance sheet reductions, the environ- ment going forward won’t be so calm for unmanaged market indices.
FORECASTING A SLOWDOWN
Markets tend to move based on trends, not absolutes. e trend lead- ing into 2018 was for robust economic growth going forward. at changed as economic forecasts changed. While 2018 posted an annual GDP growth number of 3%, 2019’s GDP growth is forecast to be around 2.7%. Worse still, the forecast in future years is ex- pected to return to levels below 2% per year. Even though economists are not forecasting a recession, the changing trend can drive changes in the markets.
UNDERSTANDING MARKET MOVEMENT
As investors, it’s important to un- derstand what drives markets. In the short-term, they tend to react emotionally as investors think about “greed and fear.” Greed drives short- term gains as investors try to take advantage of market growth and fear drives markets down as investors try to avoid losses. Another way to de- scribe this is “momentum.” Market volatility is a swinging pendulum where rising markets build fear of the next sell-o and falling markets build anticipation of the next rally. Trying to time these reversions has proven to not be consistently e ective.
Over the long-term, markets tend to move based on the fundamentals of the economy. In a growing economy, we expect markets and values to also grow. Given the economic forecasts for GDP growth, dividends, and in a- tion, investors should plan for asset growth rates in the single digits for the foreseeable future.
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HANDLING VOLATILITY
One simple truth in investing is that what worked well over the most recent timeframe tends to lag when markets change. e last 10 years saw the rise of index investing as most money managers were not able to beat their benchmark indices. A great deal of money went to “passive” index investments.
An index is a basket of companies considered to be representative of a segment of the market. e mem- bers of the basket don’t have to have a strong nancial position or any other qualifying measure. Over time, the member companies tend to change as industries evolve. Companies may go bankrupt or merge with stronger rivals.
e low-interest rate environment of the last decade essentially provided “cheap money” to companies requir- ing nancing to maintain operations. e availability of cash at very favor- able rates has a way of masking weak nancials. Businesses that would oth- erwise fail or consolidate have instead been kept a oat. is made it possible for unmanaged indices to consistently beat money managers who are selec- tive in their investment choices.
As debts come due, volatility in the indices will return as businesses with weak nancial positions have to re - nance at higher interest rates. Just as real estate markets go from buyers’ markets to sellers’ markets the nan- cial markets go from “darts thrown at random investment options” to “care- ful security selection.”
We are in a money manager’s envi- ronment now and I recommend cau- tion with the indi-
ces going forward.
Seek professional advice and favor a high credit qual- ity investment ap- proach.
Patrick Yanke is a Raleigh-based nancial advisor. Opinions expressed here are mine and not necessarily those of RJFS. The information is not a complete summary or statement of all available data necessary for making an invest- ment decision and does not constitute a recommendation. Investing involves risk and you may incur a pro t or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. Asset allocation and diversi cation do not guarantee a pro t not protect against a loss. www.yanke nancial.com.
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