Volatility: Here Today, Gone Tomorrow?

Volatility: Here Today, Gone Tomorrow?

Volatility is an inevitable part of investing. Yet when markets get bumpy, opportunities can emerge for patient, value-oriented investors.

Stock market volatility can emerge quickly and unexpectedly. But investors inclined to sell at the first signs of price declines should bear in mind that volatility can retreat just as quickly, too...creating potentially attractive entry points for active investors targeting specific companies.

Consider the last two notable spikes in the CBOE Volatility Index (VIX) Index —  associated with the UK Brexit vote and U.S. Presidential election.

Brexit bounceback - June 2016
  • The day after the 2016 Brexit vote, the VIX nearly doubled—jumping from 13.47 on June 3rd to 25.76 on June 4th. But the index then retreated, and in only 12 trading days was lower than before the vote. 
  • And while the S&P 500 lost 5.6% of its value between June 8th and June 27th,  just 8 trading days later it was higher than before the sell-off. . 
U.S. Election bounceback -- Nov. 2016
  • In the days leading up to the 2016 U.S. presidential election 2016 (10/24-11/04), the VIX jumped from 13 to 22.5—but quickly reversed course and reached a low for the year on December 20th
  • In similar fashion, the corresponding 3.1% drop in the S&P 500 between October 24th and November 4th  was more than recovered by November 9th.

 

Volatility: Peaks and valleys

CBOE Volatility Index (VIX) Index: August 25, 2014 – August 23, 2017

Source: Bloomberg, as of 7/18/16. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

 

Putting volatility in perspective

Volatility is an inevitable phenomenon, but it does not preclude gains for investors. That's because it may reflect shifts in strength between different countries’ economies and currencies — or new leadership among asset classes and industry sectors. In fact, volatility within and among sectors and industry groups can be quite pronounced, even during periods when the overall market appears calm.

There will always be surprises that jolt markets, but selling in response to temporary volatility can mean locking in losses that might otherwise be erased over subsequent months. In fact, the likelihood of earning a positive return can increase with time in the market.

Fear-driven selling can also undermine the potential benefits of active investment management. After all, volatility can lead to valuation discrepancies between securities, sectors and asset classes. That can open the door for active managers to make new acquisitions at lower prices or to lower the average cost basis in existing holdings.

 

You can’t diversify uncertainty, but you can diversify risk

The fact that volatility tends to arise suddenly can certainly unnerve investors, but panicking is counterproductive. The wiser approach is to hold a well-diversified portfolio that isn't too focused on one particular asset class or investment thesis.  That can not only help stabilize returns, but also discourage other counterproductive behaviors, like chasing today's "hot" investments rather than those with the potential to lead the market tomorrow. 

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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Diversification does not guarantee a profit or protect against loss.

Active management does not ensure gains or protect against market declines.