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3 Investing Strategies to Help You Weather Higher Volatility

By Kate Warne November 02, 2018

Markets became more volatile in October, with many big daily moves that have put U.S. stocks down about 10% from their recent record highs. A 10% drop marks a correction, and historically, corrections have occurred about once a year on average. We think this is a return to normal volatility, although it may not feel that way.

Translating Points into Percentages

Keep in mind that while a 300-point move in the Dow may seem large, this actually translates to a shift of about 1% when the Dow is around 25000. Over the past five years, stocks have changed by 1% or more about 3.5 times per month.

We think higher volatility is likely to persist. As investors digest changing indicators, they’re facing less familiar foods, and markets are experiencing some indigestion. And that translates into sharp and sudden reactions to earnings and economic news, including announcements about trade restrictions and tariffs. The midterm elections could also trigger a bout of volatility.

But higher volatility doesn’t mean the end of the bull market; in fact, it’s frequent in the later part of the economic and market cycle as investors update their short-term expectations. Over time, though, the positive fundamentals are what we think will matter. Strong earnings growth and solid economic growth can drive stocks higher over time.

What’s Behind the Volatility?

The outlook is changing in four ways:

  1. We think the pace of economic growth will slow from about 3% in 2018 to near 2.5% in 2019 as the effects of the tax cuts and higher government spending fade. Higher tariffs may also crimp growth. We think the pace remains above the average rate during this long expansion and don’t think a recession is on the horizon due to solid job growth and still-strong consumer spending.
  2. Company earnings are up more than 20% in 2018 due to the effects of the corporate tax cut and better economic growth. As we look toward 2019, earnings should keep growing but at a slower pace. And there’s a lot of uncertainty about how much earnings will slow. We think they’ll be up 8% to 9% in 2019, which is strong enough to help support rising stock prices.
  3. This bout of volatility started with concerns about rising interest rates. We think interest rates will continue to rise slowly as long as economic growth is solid and inflation remains near the Federal Reserve’s 2% target, which is what we expect. But investors are watching closely for any signs of change, which might persuade the Fed to either pause or increase rates more rapidly.
  4. The global economy is growing more slowly than expected, and the dollar has been rising. As a result, international stocks have lagged, and emerging markets are down more than 20%. But those are also concerns for the U.S., and recent slowdowns have often been followed by better growth. We think that’s likely to happen again.

3 Actions to Consider for Long-term Investors

  1. Remember your portfolio is designed based on your risk tolerance, time horizon and financial goals. It generally doesn’t match the market, so your portfolio doesn’t rise or fall as much as the S&P 500. Make sure you have realistic expectations for how your investments are likely to perform over time. After five years when the S&P 500’s return has been almost 14% per year, we think returns of 5% to 6% annually are more likely in the future.
  2. Check your asset allocation, and rebalance your portfolio to the right mix of stocks and bonds for your situation. In the first three quarters of 2018, bond returns lagged stocks, since bond prices tend to fall when stock prices rise, lowering overall portfolio returns. But bonds helped steady portfolio values in October. If higher market volatility made you uncomfortable, you may need to add fixed income.1
  3. Consider adding international equity investments, which have lagged U.S. stocks.2 The still-positive fundamental outlook means pullbacks can be opportunities to add investments at lower prices. International equity investments outperformed U.S. stocks after lagging in the past.3 They also have higher dividend yields and more attractive valuations, and trade agreements would be a possible catalyst for better performance.

Higher market volatility is normal, but it can be uncomfortable. Holding an appropriate mix of investments, focusing on the positive fundamentals and maintaining realistic expectations can help you take a longer-term perspective.

Important Information:

1Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.

2Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

3Past performance is not a guarantee of what will happen in the future.

This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.

More Resources:

Mixed Earnings and Economic Data Spark Higher Volatility

Consider the opportunities created by short-term pullbacks during swings in the stock market.

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