In 2017, volatility in the stock market was like a walk in the park on a warm spring day. It was sunny, mild, and an overall pleasant experience. But in 2018, volatility rolled in like one of those thunderstorms that seems to come out of nowhere, leaving everyone unexpectedly drenched.
Over the last several years, you have experienced one of the least volatile market periods on record. Of the 404 trading days on record through the beginning of February 2018, the market never experienced a five percent correction.1 In fact, in 2017, there were just eight days that the S&P moved more than one percent in either direction.2 However, that 404-day trading streak has finally ended, and the impact may be immediate.
The cause of market volatility
Today’s current correlation between equity and bond prices, and increased volatility, may have left you looking for answers.
First, rising interest rates have left many investors on edge. Rates have been rising steadily since late 2016, and the Federal Reserve has signaled that additional hikes are on the horizon. Consider this – the benchmark 10-year Treasury note recently hit 2.96 percent in early May, up from 2.44 percent at the beginning of 2018.3 While the increase isn’t all that surprising, the speed of its trajectory is.
With rising rates comes fear of inflation. Wage growth, rising debt, and high producer prices all point towards increasing inflation and investors are beginning to reassess the value of their equities and corporate bonds.
Another fear-factor worth noting – increased trade tensions between the U.S. and China, Canada, Mexico, and Europe. In February, President Donald Trump, unexpectedly announced he was imposing tariffs on aluminum and steel, sparking fears of an impending trade war. As a result, Wall Street started selling, and volatility started resurfacing.4
The potential solution
As liquid investments, traded equities experience ups and downs with the markets. And while they offer the potential for capital growth, they also tend to experience price volatility.
One potential solution to reduce portfolio volatility: portfolio diversification that includes allocations to investments with lower correlation to the broader equity markets such as alternative investments like real estate and credit.*
A time for active management to shine
Over the past decade, active fund management has struggled, accelerating the surge into passive equity strategies. But when markets tumble, or volatility makes an appearance like it has in 2018, active management offers the potential to maneuver and avoid trouble spots. Essentially, active fund managers are playing defense and helping you protect against downside risk. Passive management, on the other hand, locks you into a benchmark.
Given that political and economic changes may have contributed to heightened market volatility, it may be time for you to look into active management and its potential to both avoid loss and increase returns.
A look ahead
Overall, 2017 was an unusually calm year and shouldn’t be considered the norm. This quiet in the market encourages excessive risk-taking, and now you may be feeling the effects.
The recent increase in volatility is a potential transition into more normal market conditions. The real question is whether this volatility is going to end up as part of a healthy medium-term market reset, or it means greater economic and financial uncertainty ahead.