What to make of recent market volatility?

12 November by Joe Byrne in Investments

What to make of recent market volatility?

In the past, we have written how volatility can be a friend to the long-term investor, by providing the opportunity to add to investments when prices are lower. October has provided an interesting test to this point, with global share markets finishing October down 6.5% on average (albeit only partly offsetting a 16% rise over the previous 12 months).

For most investors the outcome will have been much smoother than this. This is due to:

  • Diversification across asset classes, particularly holding some fixed interest investments to smooth some of the variability in share returns. 
  • Leaving some global share investments deliberately “unhedged”. This means that any fall in the NZ Dollar would add to their value (as often happens during more significant market stress).

“Corrections” are not unusual

The reality is that “healthy” market corrections are much more common than significant declines. Significant declines, such as the Global Financial Crisis (2008), are usually driven by a large shock to the economic system. In contrast, corrections can typically be the result of short-term sentiment driven by fear or the news of the season. For a time, this tends to overshadow the longer term, more stable economic environment.

Long-run performance suggests that investors should typically expect at least a 5% drop in share markets at some point every year, and a 10% fall every other year. Because of growth in the rest of the year, this has not stopped 75% of the past 70 years delivering a positive outcome for share markets – and 90% of all 5-year periods. This is the long-run potential that share investments provide.

Economic background is positive

Although politics and trade have dominated the news headlines recently, for some time there have also been some very positive fundamental drivers within global share markets. The U.S. economy is performing well, with low unemployment and business sentiment indicators in positive territory by a healthy margin. Company earnings growth forecasts remain positive, with expectations of 15-20% growth over the next year; and relative to earnings, share prices are around 10% below their long run average. These provide fundamental support for share market investments and therefore lend support for the “correction” scenario, rather than a more significant decline.

What happens after market corrections?

A typical “correction” is not the end of the world – far from it; as long as the economy is stable, and valuations are not unreasonably high (which is currently the case). In those cases where fundamentals have continued to support an overall rising market, the average return in the year following a correction has been a strong 24%.

Discipline is key

This simply illustrates that just because markets have fallen, does not normally mean they will continue going down. Indeed, such an environment can be very healthy for stock markets as valuations become more supportive.

This reinforces the need to follow a disciplined investment plan, as volatility can indeed be a friend to the long-term investor. Who does not like a sale?

Please contact your financial adviser if you have any questions and /or to determine if now is a good time to make additional investments.

Article by Joe Byrne, BA, AFA - Read More

Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular investor’s objectives, financial situation or needs.  Any opinions contained in it are held as at the report date and are subject to change without notice.  This document is solely for the use of the party to whom it is provided.

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