Why Volatility Is Here To Stay

Eight hundred point swings in the Dow have been alarmingly regular events in the last month. Swings that large represent a 3% change in the 30 most important stocks in the United States — in one day. And it’s not just the Dow. Similar moves have been hitting the S&P 500 and stock markets outside the US. Even the benchmark 10 year US Treasury bond has been flip flopping with large price changes. Is this the new and harmless normal or a brightly flashing warning sign? Let’s start the year with a closer look at these dramatic ups and downs.

Even bigger swings

The world bond and stock markets saw corrections of 10%+ and bear markets of 20%+ in 2018. After the high-teen stock returns of 2017,  the suddenly shrinking returns of 2018 and volatility worldwide, many investors may be wondering if the worst is yet to come. They point to repeated volatile declines as signs of something…a recession, a structural financial problem, a breakdown of order, a war or “just something” that ends the 10 year upward global move of stock and bonds.

Why markets are so volatile

I suggest that all global markets are now more volatile and will be for years to come because of the cult of personality of our leaders. I am referring to Trump, May, Merkel, Abe, Xi and Putin. Those six leaders will be in power at least until 2020. Xi and Putin have no term limits so they may be there for a decade. Abe has just broken the record for longest serving leader in Japan and Merkel is not far behind in Germany. And then there is the US election in 2020.

These six leaders have vastly different goals and styles, but share one big similarity: they are unpredictable, voluble, enigmatic, horse-trading heads of big economies. They regularly shake markets with plans, cancellations, and reversals. Their bold, often surprising and sometimes contradictory comments play out in real time in the media. With this cast in charge of the world, continued market volatility should be expected.

Context and Perspective

Why the sudden uptick in volatility since October? There are several suspects. Some blame herd-like computerized trading. In 1987 the same thing was called “portfolio insurance.” As it was in 1987, the US economy today is strong. For example, total retail sales rose 5% from November 1st to December 24th, the strongest in years, according to MasterCard. We might be flirting with a bear market but that doesn’t necessarily mean we are heading into a recession.

Consider what is NOT happening right now: we are NOT seeing signals of a breakdown in the functioning of the financial system like we had in 2008. Unemployment is NOT rising. Corporate earnings are NOT in peril.

And there’s more. We have an accommodative monetary policy. Fed Chairman Jay Powell was picked for the job because of his flexibility. He has already demonstrated that in the last three months and his views on the financial system mesh with Treasury Secretary Steve Mnuchin. He’s likely to stop raising rates very much in 2019.

Our government is spending more money than ever. Inflation is subdued. Outside the US, India and China are growing more than 6%. Brexit is over after March 30th. We’re still in a global economic expansion. All these factors point to solid fundamentals for stocks in 2019 and a strong financial system.

Against this backdrop modern swings of 800 or even 1000 points are still unnerving, but mean very little. Stock performance is not a reliable predictor of future economic performance. Meanwhile, stock market volatility can be good for your portfolio. Volatility raises the cost of capital. Scarce, expensive capital helps weed out weak companies and poor ideas.

Steps you can take now

We have already rebounded from the brink of a bear market in 2018. The most important step you can take now is to maintain your diversified portfolio through 2019 and 2020. Keep enough cash available to cover known expenses and reduce the emotional rollercoaster of market gyrations. If you are keeping a lot of cash on the sidelines consider the liquidity, yield and tax advantages of Treasury Bills. Above all, stay in touch with any questions no matter how small, obvious or seemingly unimportant and we’ll do the same. Call us if you have any questions. 2019 is going to be a great year.