Over the last 12 months, investors may have felt like they have seen remarkable bouts of market volatility, despite the fact that the CBOE VIX Volatility Index has experienced relatively few serious spikes. The most notable VIX event over this period was in December 2018, as the S&P 500 declined close to 20% from its prior highs.
Bespoke Investment Group has recently noted that the market’s many gyrations have been within a relatively narrow range for many months, similar to some past market periods:
“In the chart, we strip away the daily price action of the S&P 500 and only show the index’s 200-day moving average (DMA). Looking at things this way shows how despite the wide swings we have seen over the last year or more, the S&P 500’s 200-DMA has been in a tight range for well over a year. Not only that, but the current consolidation period looks awfully similar to prior consolidation periods that we saw back in 2011/2012 and 2015/2016.
“What’s notable about this period and the prior two is that each time, the spread between the S&P 500’s 200-DMA 52-week high and low has been less than 3%. … While there have now been three periods in the last ten years where the one-year range of the S&P 500’s 200-DMA was less than 3%, prior to that there were only four other periods going all the way back to the late 1920s.”
That said, there is no doubt that intraday and weekly moves for the market have rattled many investors, and we have seen numerous daily headlines of “Dow soars” and “Dow tumbles.”
Bespoke said in early September, as quoted by CNBC, “Ever since early August, investors are being whipped around by a series of contradictory tweets, headlines, and ‘reports.’ One day the trade war with China is at the point of no return. The next day the two sides are talking.”
CNBC added, “This back-and-forth has led to a slew of volatile moves in stocks. Over the past 24 trading sessions through Wednesday’s close (9/4), the S&P 500 has posted 12 moves of at least 1%.”
The American Association of Individual Investors (AAII) had an interesting perspective on volatility, and the media and public’s perception of it this year:
“This week’s relative calm in the markets is likely a welcome change. It follows an approximate six-week period where the S&P 500 index swung in a 186-point range. The point range equates to an approximate 6% move in both directions.
“If it felt like the market was even more volatile, it’s likely because you’re paying attention to intraday moves and focusing on point changes instead of percentage changes. … These percentile moves equate to larger absolute point moves with major indexes at current levels relative to what we’ve seen in the past. … A 200-point move in the Dow is no longer significant.”
The AAII also noted that compared to the last eight years, 2019 has actually seen a rather average number of days where the S&P 500 moved up or down by 1% or more (so far, at least). The point being that volatility tends to arise in a concentrated time period, giving the impression this year has been more volatile than most.
Real or perceived, volatility is a concern
Nonetheless, financial advisers, particularly following the steep decline in the S&P 500 in late 2018, have had to field questions and concerns from some nervous clients regarding their portfolios—and the preservation of their capital.
Three-quarters of advisers surveyed this spring by Eaton Vance said “fear” was the “primary current motivator” for their clients. Nearly 90% of advisers said the political environment was becoming a “factor in client conversations about the market.”
While sentiment has improved markedly since the beginning of the year, advisers expect volatility to remain a primary concern for the financial markets. Generating income, growing capital, and managing tax exposure remain important objectives as advisers guide their clients, but fell below the importance of “managing volatility” earlier this year.
Ideally, when a client and his or her financial adviser have jointly developed a goals-based financial plan, and developed an investment plan that strives to reach those customized goals, questions from clients around volatile markets will be minimized.
Unfortunately, that is not always the case.
Helping investors manage volatility through risk management
In Proactive Advisor Magazine’s article “Clients understand volatility—except when it happens,” Richard Lehman, a professor of behavioral science, wrote,
“Human brains are riddled with pesky emotional and cognitive biases that can overpower even the most well-considered plans. …The reasons are rooted in psychology and are as inevitable as the closing bell at the end of each trading day.”
Professor Lehman offered several constructive suggestions for both financial advisers and their clients when concerns about market volatility arise:
“Review again with the client their financial plan objectives and how they relate to their overall life goals. Ask them the critical question point-blank: ‘Are you still on track to meeting your long-term financial and investment objectives?’ With a well-constructed financial and investment plan that was developed with the client’s risk tolerance at the forefront, the answer should undoubtedly be a calming ‘yes.’
“Have a frank discussion about the trade-offs of different types of portfolio allocations, the depth of exposure to equity markets, and the use of buy-and-hold passive strategies versus more active, risk-managed strategies. Would this client be more comfortable with a less-volatile portfolio construction, understanding that the consequence might be some ‘underperformance’ versus the major market benchmarks in times of roaring bull markets? However, they must understand this is importantly counterbalanced through the use of strategies meant to mitigate the worst effects of bear markets.”
This is sound advice from an expert who not only is an authority in the field of behavioral finance, but also has had decades of hands-on experience in the financial markets working for major Wall Street firms, banks, and financial-data companies.
Whether volatility is real or “just” perceived, I like the way one of the advisers interviewed for Proactive Advisor Magazine summed up his view of helping clients manage portfolios for sustained performance—and enhanced “peace of mind”:
“Encouraging behavioral adherence, or the ability for an investor to adhere to their long-term investment strategy over the course of the full market cycle, is one of our chief missions as wealth managers. Prudent risk management optimizes the likelihood of behavioral adherence, which, in turn, optimizes the likelihood of investing for success over the long term.”
Market update by FPI Research
Equities were largely up last week, with the riskiest securities gaining the most. The S&P 500 was up about 1%, and small-cap stocks (which have been significantly underperforming large-cap stocks recently) were up nearly 5% for the week. This was a theme that continued throughout global equity markets: Securities that had fallen the most for the year significantly outperformed securities that had the most gains for the year.
In the U.S., this tended to mean that small-cap stocks and value stocks outperformed large-cap stocks and growth stocks. The momentum factor took a major hit, essentially eliminating all gains year to date. For example, the ETF MOM (the AGFiQ U.S. Market Neutral Momentum Fund) fell over 10% last week. The ratio of momentum factor performance versus value factor performance also fell, indicating the market’s perception of the momentum factor (the idea that securities that move up will continue to do so and securities that decline in price will also continue to do so) is shifting. While some evidence supports that the momentum factor itself is mean reverting (i.e., that it will experience periods of under- and outperformance), this was a precipitous drop the likes of which we have not seen since the last financial crisis.
For the past 12 months or so, small-cap stocks have been underperforming large-cap stocks, though it looks like that trend may be ending in a spectacular way. Indeed, this price action is continuing Monday morning (September 16), with the Russell 2000 outperforming the S&P.
Given what happened last week, it’s easy to think that perhaps the momentum factor is failing. However, historically, this factor does occasionally experience weeks such as these, and that doesn’t necessarily dampen the long-term gaining nature of the momentum factor. For example, since its launch in late 2014, the S&P Momentum Factor Index has outperformed the S&P by about 11%. This index takes a very simplistic view of market momentum, and more sophisticated applications should be expected to do even better.
That being said, many of our momentum-based strategies were able to perform well, despite the underlying churn in the markets. Our absolute-return-based strategies, such as Self-adjusting Trend Following and Classic, were up (in these cases, 1% and 2%, respectively). Our non-trend-following strategies also navigated the week well: Our new Quantified Pattern Recognition Fund (QSPMX), the latest iteration of our S&P Tactical Patterns strategy, was up 0.70%.
While weeks such as last week can seem disorienting, our strategies are designed to navigate them for you. Such weeks have happened before and will happen again. We’ve modeled these situations into our strategies in an effort to give our clients the best long-term experience possible.
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