Volatility Is Back – 3 Things To Know
Investors often assume that market trends represent reality. With headlines referring to “the stock market’s big sell-off” and “the stock market plunge,” one would think that we were in the midst of a significant correction. However, the stock market is less than 5% below its all-time high – in the traditional sense, we have not even entered “correction” territory.
The issue seems to be that investors had come to assume that an environment characterized by low volatility and a rising equity market was reality – in other words, they allowed perception to overwhelm objectivity. We all know that volatility is normal, and that the environment we have been in for the past year was abnormal. But why are investors so surprised now that volatility has returned?
Rates have risen quickly on the back of more hawkish rhetoric from policymakers, an acknowledgement of the strength and breadth of the global expansion, and a rise in inflation expectations. This has come into conflict with the idea that policymakers would normalize slowly, the acceleration in global growth was merely a flash in the pan, and inflation would remain MIA, destabilizing equity markets in the process.
So what is an investor to do? The most important thing is to avoid letting emotion determine one’s outlook. These market moves serve as a reminder that volatility is not dead, but there are plenty of reasons to remain optimistic about the year to come.
- Economic growth remains solid and earnings estimates are moving higher.
- Rates are rising from low levels, and the threshold beyond which the correlation between equities and 10-year U.S. Treasury yields turns negative is around 3.50%.
- The Fed remains firmly in the “normalization” camp; only when Fed rhetoric shifts from “normalization” to “tightening” will risk assets come under sustained pressure.
In sum, investors would be well served to understand and differentiate between what the facts are saying and what their senses are suggesting. The key to any good investment decision is to leave emotion out of it; this is not about forecasting the future, it is about seeing the present with clarity.
Volatility is back in town
Absolute value of daily change in S&P 500, 50 day moving average
Sources: Standard & Poor’s, FactSet, J.P. Morgan Asset Management. Data are as of February 2, 2018.
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