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.