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Who's afraid of the big bad V?

So, market volatility is back with a vengeance. The big, bad V! By mid-April, the S&P 500 had moved up or down at least 1% on 28 trading days already in 2018 — 15 increases and 13 drops. To put that into context, there were just 8 swings of 1% for the S&P 500 all of 2017.

But is volatility bad, or are we having more of a V-Festival? Well, vol can be bad, but generally not. Normally not – and by ‘normal’ I mean in the statistical sense. Without volatility it is harder for investments to make the desired levels of return we expect. If you don’t want the returns, fine. But if you do, take the vol on the chin, and manage it through sensible diversification, but don’t try to avoid it.

Also, investors tend to focus on the wrong type of risk. Sure, geo-political risk is fairly heightened at the moment, but we shouldn’t confuse geopolitical risk for market risk. Ken Fisher’s “Markets Never Forget” – see Mark’s recent blog post– has a table 4 pages long, citing political and economic disasters such as 1986 with US bombing Libya, the Chernobyl disaster, US tax reform, space shuttles exploding. The S&P put in a +42% return. And no, it didn’t ‘correct’ the following year. Or the year after, or the year after that…….

Some of the most (apparently) unstable periods in political history have still provided good returns.

So, this year, when investors started to get nervous in February, and volatility spiked (VIX at 37, from an all-time low of 10!) it was misplaced. Remember the VIX is an index of implied volatility. It is effectively a nervousness monitor – the high price that markets (people) pay for S&P index options is only explained by the fact they are scared. But what of? Generally geopolitical issues. But markets were also pessimistic on the earnings season and many investors de-risked and reduced equity allocations. The bull had retreated. The big bad V was here. January into February, the S&P500 and NASDAQ composite fell 10%.

But Corporate America earnings came good, inflation stayed low and rates didn’t shoot through the roof. The NASDAQ is up close to 10% for the year to 5 June, the S&P is pretty much flat. No disasters, even with all the geo-political uncertainty. The short-term political noise was a distraction to investors. But it’s hard not to react to it – it’s human nature to run scared if others do too!

So how to manage through the turmoil? Keep calm and carry on investing. Personally, I just stay diversified and take the long run – and I’m lucky to have a discretionary manager at a reasonable cost for my pension. But if you don’t, it’s still not rocket science. Some anecdotal, but enlightening stats on volatility and investment returns:

With a big “bear swings” in equity markets ending in 1982,1987,1990,2002,2009 you would think that retiring in 2010 after 35 years of hard work would be unaffordable! What would have happened 1975-2010 to an ‘average’ equity investor?......

An investment in the US equities market – benchmarked as the S&P500 index – achieved an annualised average 11.2%. OK, 10.2% after management charges. Still, not bad. But with 17% volatility! That means most years would have earned you a return from -6% to +28%. That’s a big range! Most people wouldn’t last the ride, mentally. So? Don’t avoid the big, bad V, just diversify.

A diversified investment across global equities, large, mid, small, FI, real estate, commodities would have achieved an annualised average of 10.9%, call it 10% after charges. But only vol of 10%.

So, take the long-road to retirement, with a few rolling hills along the way, not the rollercoaster. Whichever way you go, the road ain’t flat!

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