A Wild Ride: Understanding Market Volatility

On Monday, August 24, 2015, the Dow Jones Industrial Average plunged 1,089 points in the first 10 minutes of trading, the largest intraday point drop in the history of America’s oldest stock index. The benchmark rallied, regaining almost 1,000 points, only to slip again and close down 588 points — the most volatile day in a turbulent stretch that has seen the market bounce around while trending downward.¹

As an investor, you might feel nervous about volatility, especially when the trend seems to be heading lower. However, it’s important to consider the reasons behind the market swings and maintain a long-term perspective.

China, Oil, and the Dollar
Three international concerns are at the heart of current volatility: economic weakness in China, low oil prices, and a strong dollar. All three are interconnected, but though they may slow the global economy, their effect on the U.S. economy and stock market reflects fear and uncertainty more than a direct threat.

A faltering Chinese economy, including reduced demand for oil, may affect trading partners that depend on exports to China. However, China accounts for only 7% of U.S. exports, and exports are a relatively small sector of the U.S. economy. Low gas prices and a strong dollar are a mixed bag — good for U.S. consumers while challenging for some multinational businesses.²

Balanced against these international issues is a stronger U.S. economy, as well as improving business results. On September 25, the U.S. Bureau of Economic Analysis released its third estimate of second-quarter 2015 economic performance, revising annual real GDP growth from the advance estimate of 2.3% (released before the big market drop) to a more robust 3.9%. Though consumer spending drove the overall increase, the revision also reflected increased business investment. Corporate profits rose at a 3.5% quarterly rate after falling by 5.8% in the first quarter.³

These are strong economic indicators that bode well for the long term, but uncertainty often has an outsized effect on short-term market performance.

What Will the Fed Do?
Adding to the uncertainty is concern about when the Federal Reserve will raise the federal funds rate. Despite expectations that it might pull the trigger at its September meeting, the Federal Open Market Committee (FOMC) held steady, saying “recent global economic and financial developments may restrain economic activity somewhat.” At the same time, the FOMC affirmed its belief that the U.S. economy is on the right track, and most members still anticipate raising the federal funds rate this year.⁴

In a measure of how interest-rate uncertainty makes investors nervous, the Dow dropped 121 points in four minutes after the Fed announcement and regained 119 points in the next eight minutes. It closed with a modest loss of 65 points or 0.39%.⁵

New Trading Strategies
Along with concerns about the global economy and domestic interest rates, new trading strategies may be adding to the volatility, creating rapid large-scale market shifts that do not always reflect investor sentiment about individual stocks. In one telling statistic, during the 15 trading sessions ending September 9, there were 11 “all or nothing” days when at least 80% of the stocks in the S&P 500 index either rose or fell — a daily mass movement unmatched in records dating back to 1990.⁶

Maintaining Perspective
Although a market loss may be difficult to accept, it’s important to keep the numbers in perspective. The S&P 500 index more than tripled in value from its recession low in March 2009 to its most recent high on July 20, 2015. The 9% loss from July 20 to September 25 still left the index up 185% over the last six-and-a-half years.⁷ No bull market lasts forever, but the recent pullback doesn’t necessarily mean the market has no more potential for gain, and it may be healthy in the long term.

Some analysts think stocks may have become overvalued during the long bull run, and a pullback or a correction (defined as a market drop of 10% from a previous high) can set a more realistic “floor” for future market growth.⁸

Fleeing the market during a downturn means you are not in a position to take advantage of growth on the upswing, as many investors learned when they left the market during the recession. In fact, a down market may be a buying opportunity, but it’s just as important to be careful about purchasing investments as it is to be careful about selling. In most cases, it would be wise to maintain a steady course and stick to the sound investment principles you used in building your portfolio.

All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. The S&P 500 index is an unmanaged group of securities that is considered to be representative of U.S. stocks in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

1, 8) money.cnn.com, August 24, 2015
2) The Wall Street Journal, August 24, 2015
3) U.S. Bureau of Economic Analysis, 2015
4) Federal Reserve, 2015
5, 7) Yahoo! Finance, 2015
6) barrons.com, September 10, 2015

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.