What Recent Market Volatility May Mean For Investors

Investors are right to be concerned about the pace of Europe’s recovery: there was a significant loss of momentum in many European economies in the summer, which has continued into the autumn. The European central bank has made clear its commitment to taking more action to reflate the economy. But for the ECB’s policies to work, businesses need to feel confident in the future of the recovery, which means governments need to do their part to support demand and raise Europe’s potential through structural reforms. This is a long and difficult road. But rising private investment and employment in Spain shows that efforts to improve competitiveness can translate into faster growth. In the coming weeks there are several factors which could help turn European sentiment and convince investors that a modest recovery in Europe remains on track:

  • The completion of the ECB’s Asset Quality Review (AQR) for European banks has the potential to lift concerns about the underlying health of Europe’s banking system.
  • The 9% weakening in the Euro since June should start to be reflected in European corporate earnings: 45% of revenues for European large cap companies come from abroad.
  • We are also beginning to see small victories on the reform front, such as Italy’s recent vote to advance Matteo Renzi’s Jobs Act. The French government has also begun to talk about a major programme of reforms.
  • The sharp fall in the price of oil, with the price of a barrel of Brent crude falling to $83, will also be a net positive for Europe, acting like a tax cut for businesses and households even if it makes the job of pushing up inflation a little more difficult.

Putting volatility into perspective

In the summer many worried that very low levels of market volatility spelled investor complacency – now there is concern that volatility has swung the other way. But neither is particularly unusual. The VIX index, at 27, achieved similar levels in 2012, and was almost double that in 2011. A VIX index closer to its long-term average of 20 should still be expected for the long run. Graph One
The main point for investors is to keep this volatility in perspective. From April to July, there wasn’t a single day with a +1% or -1% return on the S&P 500. Relative to those low levels, today’s market moves appear staggering. Relative to a longer history though, such moves can be common over short periods. Pullbacks over many days of 1% to 2% historically occur multiple times a month, even in good times. Pullbacks of 5% to 10%, where we are today, occur between once per quarter to once per year. The current market pullback is not, in and of itself, a reason to overreact. The following chart from our Guide to the Markets shows just how normal it is to have market drawdowns, but also how normal it is for markets to recovery from them.

Market Commentary

Maintaining a disciplined approach
As you know, we have a strong academically proven investment process that was developed to help you work toward your financial goals. While we monitor economic and market developments closely, we don’t let the noise of day-to-day events determine our actions. It’s important for you to understand we listen to what is happening however much of the time we decide to do nothing as a long term buy and hold strategy has proven to work. Although no strategy is assured success or protection against loss, we have confidence in our process. It is the reason we sleep well at night.