Market Volatility – Friend or Foe?

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In recent months, the markets have taken investors on an emotional rollercoaster ride. However, there are key differences between this rollercoaster and the one at Canada’s Wonderland amusement park. On that one you sit looking forward, and can see what’s coming next. However, as an investor, you face backwards on your ride through the markets, and all you can see is what has transpired.

When markets are going down, and all you can see is the recent past, you have no way to tell when the decline will end, or if it will end at all. Human nature can be an investor’s worst enemy, as it can incur doubt as to whether investment programs are sound. People tend to extrapolate current market trends and assume the worst.

The graph below plots the twenty-five year performance of $1,000 invested in the S&P 500 index using a logarithmic scale. While the overall trend is upwards, the line is by no means smooth – it is punctuated by ups and downs – which translate into volatility. Notably, any other major stock market index measured over the same timeframe exhibits these same characteristics.

(source: Morningstar.com)

Ben Graham famously attributed this to the behavior of “Mister Market”, which was his representation of the collective conscious of investors who participate in the market. Mr. Market regularly reacts to information – or misinformation as the case may be – with a mix of panic and euphoria, rather than to the actual valuation of businesses. When the markets pare back, as we’ve seen recently, Mr. Market can only think of three words: “sell, sell, sell”. And as Ben Graham points out, Mr. Market rarely gets it right.

Should investors alter sound investment portfolios in the face of volatility?
Our investment managers have witnessed many markets like the present one. They cite the “go-go” era of the late sixties when stocks posted gains of over 100%, and how that era came to a sudden end in 1974 amidst the OPEC embargo and Nixon’s resignation. In the eighties, investors enjoyed great gains early on, only to be jolted by the famous 29.2% drop in the world’s largest stock market index on October 19, 1987. The U.S. markets recovered in the late 80s and 90s, peaking with the tech bubble of 2000, which ultimately burst, kicking off a period of negative returns that lasted until 2003.

While we prefer not to predict what the stock market will do next, this up and down pattern has repeated itself so often in the past that it’s reasonable to assume that it will continue to do so.

So what’s an investor to do?
The most important thing investors can do is to stay the course. It is sensible to review your investment portfolios against your financial planning objectives: stay diversified and use the benefits of rebalancing.

We know that short-term market volatility is a reflection of the emotional state of the investors who participate in the markets, and in no way representative of the value of the businesses it represents.

Therefore, rather than shying away from investing during volatile periods, we encourage investors to anticipate increased opportunities. Our investment process, with its strict adherence to using seasoned independent investment specialists, maintaining a sound intellectual framework and frequent rebalancing, remains unchanged.

As always, if you would like to review the risk levels of your current portfolio, please contact your closest CARP Certified Advisor for an appointment.