Lessons Amid Low Volatility

What follows is an excerpt of our quarterly client newsletter...

We are halfway through 2017 and three quarters through the 2010s. When the decade began, doubt lingered whether the Great Financial Crisis (GFC) had passed. The S&P 500 remained more than a third below its pre-crisis peak. Pain was fresh and pessimism widespread.

Many 2010 investors’ jaws would drop at what ensued: seven-plus years of an ascending U.S. market. Still, the most unexpected feature of today’s stock market may be its lack of volatility. VIX, which measures volatility of the S&P 500, closed at record lows in May.

A decade after the most traumatic financial event of most investors’ lives, markets are calm. The tranquility is notable beside the decidedly hectic political landscape.

There is debate about what the lack of turbulence means – bullish signal or sign of complacency? We’ll leave that to the prognosticators. There is more to gain from reflecting on the transition from extreme volatility to today.

Investors commonly fight the last war. In 2010, fresh psychological wounds motivated many to avoid a repeat experience.

Recognizing this, Wall Street marketed solutions to yesterday’s problems: see these hypothetical returns had your money only been here. People flocked to promises to be “uncorrelated to stocks,” “limit downside” in future crises, and provide “stock-like returns” without the volatility. Trillions poured into these investments, often in the form of high fee hedge funds.

Ironically, investors would have naturally experienced lower volatility had they held onto stocks. They likely would have had much better returns too.

People often overstate recent history when projecting the future. In fact, the next crisis likely will be different than the last. Volatility is cyclical and an unavoidable feature of investing.

Post-GFC investors compounded portfolio loss with the opportunity loss of disciplined, long-term investing. For some, taking less stock risk may have been warranted. Too many, though, overlearned the GFC and treated volatility-reduction as a worthy and necessary long-term strategy.

An effective defense against volatility is to (1) have a long-term perspective, (2) identify a strategy, and (3) (this is the hardest part) stick to it.

Choppy waters will return. While they are calm today, it’s important to build the knowledge and resolve to weather the next storm.