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Ask Sylvia: How Should I Think About This Market Volatility?

By Sylvia Kwan

It’s been quite a time for the markets this August. Things can change very quickly in the stock market, and none of us has a crystal ball to tell us when (not even the ultra-confident talking heads on TV, believe me).

So what’s an investor to do? Spoiler alert: The answer, in most cases, is “nothing.” And here’s why.

Diversification matters

At Ellevest, you’re not just investing in stocks, or in any single asset class. Our experience tells us that the best way to protect against the unknown is a well-diversified investment portfolio, with a range of investments; in fact, you won’t find any portfolios on Ellevest.com with a 100% allocation to stocks. The investment portfolios we offer at Ellevest are diversified across stocks, bonds, and alternatives, depending on your goal.

For shorter-term goals, there’s a lower allocation to stocks to reduce the risk of a market downturn derailing you close to your goal date. For longer-term goals, there’s a higher allocation to stocks, because that may give you the time to make up market downturns, and to give you the opportunity to earn the higher returns that stocks have historically posted. Through all of this, market declines are normal and a necessary (but unfortunate) part of investing.

What investors did lately

The market has seen a lot of whiplash in the past couple of weeks. On August 5, US stocks dropped significantly. This came after China let their currency, the yuan (pronounced “won”), weaken past seven yuan per US dollar for the first time in more than ten years. That move fueled fears that China was intentionally devaluing its currency to make its exports more competitive in global markets, and that the prospects of the US and China coming to a truce were dimming.

Nervous and reactive investors fled for safer assets, like US bonds and gold — maybe thinking the drop was the start of a correction, or even a global recession. The next day, stocks rebounded after China backed off of further escalation of the trade disputes. Markets have been rising and falling since, with the Dow Jones Industrial Index falling by 800 points (aka 3%, its worst since October 2018) on August 14.

A note about “the yield curve”

This week’s headlines also informed us that “the yield curve” inverted. That means the returns people expected from short-term bonds were higher than what people expected from long-term bonds (usually, it’s the other way around, because investors demand higher returns for waiting longer until they get their money). The particular yield curve in question lately is the one between two-year bonds and ten-year bonds. (The three-month to ten-year yield curve, on the other hand, has inverted a lot over the past few weeks.)

This has drummed up a lot of noise because many people see an inverted yield curve as a sign that a recession is one or two years away. But many experts argue that today’s economy is different enough from that of the past. Plus, there’s more attention on the yield curve nowadays, which could cause investors to react more in response. So we can’t really rely on the yield curve as a sure indicator. (Again: Nobody out there has a crystal ball.)

Putting this market dip in context

Think back to December of last year, just 9 months ago. US stocks fell more than 10% that month (which is technically called a “correction”). Given the nearly ten-year bull market we had up to that point, I’d say it would be quite reasonable for anyone to believe that a pullback or correction was long overdue.

But what’s harder to predict while it’s happening is whether a decline is just a correction or the beginning of a global bear market. If an investor had pulled out of the market last December, or hesitated to invest because they were waiting for the “bottom,” they would have missed the 13%+ return that stocks have returned so far this year. In fact, the S&P 500 is only 6.18% away from its all-time high, and the DJIA is only 7% away from its all-time high.*

This is why we don’t react to market movements that are based on uncertainty — which is what is driving all of the recent volatility.

We do look for what we believe might be changing fundamentally over the long term. For example, recently, large-cap growth stocks have had particularly strong performance compared to other categories of stock. But over time, returns like this tend to revert to historical averages. Because we believe that these unusually high returns are unlikely to continue in the long run, we recently adjusted our recommended portfolios accordingly.

And about that current volatility: Given that the US-China trade negotiations are ongoing and no one knows how it will ultimately shake out, one can’t really determine what fundamentally, if any, may be changing going forward and how we might adjust our asset allocations differently. And more important, to adjust and trade our clients’ portfolios based upon optimism and expectations of successful negotiations — and then pessimism when talks break down the next — is just not the kind of investing that we believe is prudent for our clients.

The takeaway here is that the stock market doesn’t go straight up. In fact, historically speaking, stocks have had a roughly 53% chance of rising and a 47% chance of falling on any given day. People may think they should wait for a pullback to invest, but the data shows that historically, “time in the market beats timing the market.”

Volatility is often short-lived and disappears with a long-term view. We believe the way to weather periods of volatility is by building a resilient portfolio that’s diversified across different asset classes — which is what we do at Ellevest. Certain assets have weathered volatility better than others; those include assets with low correlation with the stock market, like municipal bonds and alternatives, and assets that generate cash flow, like dividend-paying stocks and bonds. That’s why these asset classes are in almost all of our recommended portfolios.

Lastly, it’s important to remember that returns come with risks. And investing in the stock market comes with the greatest risks — but historically, it has also had the best returns over long periods.

The bottom line about market drops

So the bottom line is this: Markets fluctuate over time, and one of the biggest mistakes investors make is trying to “time” the market by guessing when to buy or sell. Another big mistake they make is to “do something” (ie, sell) when markets decline.

Instead, it is our view that one of the smartest things you can do is invest regularly — a bit out of each paycheck — into a low-cost, diversified investment portfolio. This can mean you’re buying in some markets that are higher and some that are lower, but that those may even out over time. We believe the most prudent course of action is to have a well-thought-out asset allocation and keep investing steadily.


Disclosures

Ellevest’s online investment portfolios do not invest directly in individual stocks; instead, we use ETFs and mutual funds to expose client portfolios to equity markets. Those ETFs’ returns will be different from the returns quoted here.

As of the markets’ close on August 14, 2019.

Stock from companies that are valued over $10 billion and anticipated to grow faster than the market, on average.

© 2019 Ellevest, Inc. All Rights Reserved.

The information provided should not be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice.

The information provided does not take into account the specific objectives, financial situation or particular needs of any specific person.

Forecasts or projections of investment outcomes in investment plans are estimates only, based upon numerous assumptions about future capital markets returns and economic factors. As estimates, they are imprecise and hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

Information was obtained from third party sources, which we believe to be reliable but not guaranteed for accuracy or completeness.

The practice of investing a fixed dollar amount on a regular basis does not ensure a profit and does not protect against loss in declining markets. It involves continuous investing regardless of fluctuating price levels. Investors should consider their ability to continue investing through periods of fluctuating market conditions.

Diversification does not ensure a profit or protect against a loss in a declining market. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

Investing entails risk including the possible loss of principal and there is no assurance that the investment will provide positive performance over any period of time.

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Sylvia Kwan

Sylvia is the Chief Investment Officer of Ellevest. She researches and oversees Ellevest portfolios and develops the algorithms behind Ellevest’s investment recommendations.