It has been a quiet summer for the stock market, with volatility and trading volumes near multi-year lows despite increased potential for military conflict between the U.S. and North Korea among other geopolitical issues. In fact, this entire year has seen the lowest average volatility levels on record, as strong earnings and improving economic fundamentals helped push stock markets higher. With that said, volatility historically increases as summer turns to fall and we expect that trend to continue this year.
September is a key month, as the Federal Reserve is expected to begin decreasing their balance sheet while the debt ceiling debate in Washington is waged around Treasury Secretary Mnuchin’s warning that the U.S. Government will run out of cash to pay its bills by September 29th. The question we face is whether these events will have a minimal impact on the market like other geopolitical events over the past year, or will it result in a more pronounced downturn or “correction” that market prognosticators have been calling for. Regardless of the outcome, we do not see a need for investors to panic or alter their investment strategy to prepare for potential declines.
Stock markets have been extremely resilient over the past year, shaking off events like Brexit, the surprising Trump victory and numerous terrorist attacks. Markets may have experienced sharp declines around these events, but they snapped back in a matter of days which makes it extremely difficult to attempt to time investment decisions. This trading pattern contrasts with previous debt ceiling debates that occurred in 2013 and 2011. During the summer and fall of 2013, U.S. equity markets sold off by 5% or more on several occasions. Market declines were even more pronounced both in magnitude and duration during the summer of 2011 when volatility spiked to levels last seen during the financial crisis. This occurred when Standard & Poor’s downgraded U.S. Government debt from its AAA status to AA after Congress failed to raise the debt ceiling. Stock markets subsequently declined by more than 10% and took almost half a year to recover.
Given that Congress returns from recess on September 5th, and considering President Trump’s recent comments on his willingness to shut down the government, markets may become more volatile as the political debate in Washington intensifies. However, we believe it is not wise to make investment decisions based on potential short term volatility. A study by J.P. Morgan analyzed the daily returns in the S&P 500 Index over a 20-year time frame and missing the 10 best trading days resulted in approximately 50% lower return versus a portfolio that stayed fully invested. Furthermore, the majority of days with the highest returns occurred within two weeks of the ten worst trading days. Therefore, investors should make sure they have an appropriate mix of stocks and conservative investments such as cash and fixed income to weather market volatility. We believe the right combination of assets allows investors to maintain or add to their stock allocation during a market correction, resulting in superior risk-adjusted returns versus a strategy based on market timing.
Frank Fazio, III is a Portfolio Strategist at Bouchey Financial Group, Ltd. with offices in Saratoga Springs and Historic Downtown Troy. E-mail investment and financial planning questions to planningpa[email protected] or read our blog each week at www.stevenbouchey.com Information contained in this column should not be considered as the receipt of personalized financial advice and please consult with your financial adviser.