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What should investors think about market volatility in the face of all the scary headlines?
Financial markets have been very volatile over the last few days. In addition to election season being underway, all our lives are drastically changing as we make daily adjustments to the novel COVID-19 pandemic. And, the Federal Reserve is taking unplanned action. Information is coming at investors very fast. What should a savvy investor make of all these headlines?
To start, the full financial impact of the coronavirus on the economy, the markets and the global population has yet to be seen. While the economic severity remains unknown, in the short term, we know there will be an impact on travel and tourism, supply chains and business spending confidence. This, in turn, will be reflected in short-term market returns. However, these uncertainties also present an opportunity to rebalance your portfolio and look for tax-loss harvesting opportunities to offset taxes now and in the future.
On March 3, the Federal Reserve decided to cut interest rates by half of one percentage point. This was not done during one of its regularly scheduled meetings, which is different than how it cut interest rates last year. Then on March 15, the Federal Reserve further reduced rates to set the new benchmark interest rate range between 0% and 0.25%.
It also said it would purchase another $700 billion worth of Treasury bonds and mortgage-backed securities and began coordinating with other central banks to keep global financial markets functioning normally. These recent decisions could be interpreted in many ways, but it is important to keep in mind there are specific reasons behind each of the rate cuts implemented over the past year and a half. None of the reasons are the same as when the Fed cut rates back in 2008 during the Great Recession.
Finally, markets are always volatile during an election, and it is difficult to identify systematic return patterns in election years, especially as campaigns take a back seat to coronavirus mitigation. However, historically on average, market returns have been positive both in election years and the year following. This holds true regardless of whether a Democrat or Republican is elected.
Over the past several weeks, the U.S. markets have experienced elevated levels of volatility when compared to the markets over the past several years. Historically, a drop of 10% in U.S. markets occurs about every 12-18 months and is considered normal.
Over the past decade or so, Americans have been existing in a world where we have forgotten what “normal” volatility really feels like. It is reasonable to expect these positive and negative market swings to continue for now.
While the desire to pull money out of the U.S. markets and sit in cash is a natural emotional response, now is not the time to panic. Now is the time where being a disciplined investor can really pay off and can prove beneficial over the long term.
For example, if you reduce your exposure to U.S. equities while the U.S. market is down, you are selling at a low price. Then if you wait until the U.S. market recovers to re-increase your U.S. equity allocation, you are buying the same (or similar) equities again, this time at a higher price. This is the opposite of the age-old advice of “buy low and sell high.”
Now is definitely a time where an investor's comfort level with the “riskier” part of their portfolio — the stock portion — is tested. Times like this reinforce the importance of having a well-diversified portfolio among global stock and bonds.
The best thing to do is have a conversation with your financial adviser to make sure your overall equity to fixed income allocation is in line with your long-term goals, objectives and risk tolerance. Then keep your focus on taking advantage of opportunities to rebalance your portfolio or add new money to your portfolio when the market is down. These actions allow your portfolio to recover faster when the markets do turn around in the future.