The discomfort of market volatility

If you follow the financial market news, you will see this is a timely article. If you don’t and are more interested in the Olympics, or getting on with life in general, then this is still useful information that can be applied at any time.

From time to time, markets will overreact or correct, and they will incur large swings in value, either up or down. This happened with stock markets this week, first down, then back up, then down again, then flat.

This article serves to give some context. We will touch on what is happening in the global economy right now, but more importantly, we will discuss the principles around these moments of pivot point in financial markets.

 What is happening this week and why:

In recent weeks, the financial markets have been awash with news and with responses to news, which creates more news. News leads to speculation, and often overreaction.

In the UK and Europe, Following the European Central Bank first rate cut in June 2024, the Bank of England cut rates on 1st August by 0.25%, their first rate cut since 2020.  

We have a new government in the UK and there are expected to be announcements on tax and pensions within their term.

In the US, there is a lot of focus on the Federal Reserve which sets US interest rates. In July, they inferred they may delay rate cuts until they had stronger signs of inflation returning to normal. They repeated that statement last week, but the markets expected them to cut especially as jobless figures were weaker than expected. The reaction of the markets was a strong sell-off of shares. Perhaps this decision was a trigger, or perhaps it was an excuse for profit taking.

The tech sector particularly, has had a very strong run with share prices growing substantially this year. We have been stating all year that the stocks making up the ‘Magnificent 7’ – Apple, Amazon, Alphabet (Google), Meta (Facebook), Microsoft, Tesla, and Nvidia- could soon reduce to the Magnificent 2, then 1, then zero, as all stocks will follow a path of returning to market normal growth rates. Or to put is another way, everything that goes up will eventually come down for a while, and everything that is going down, will recover and go up. Indeed, this is happening.

Investing is not just about stock markets. As stock markets have incurred volatility, the bond markets have experienced a rally. For a diversified investor this is important as it will buffer a portfolio and lead to more consistent returns.

Finaly, Asia. Japan has been making headlines all year with the stock market rallying earlier in the year and surpassing its highs of 1989. When the Bank of Japan raised interest rates unexpectedly this week, it triggered the Japanese yen to rise quickly and Japanese stocks to be sold off heavily. The Bank of Japan subsequently reversed its decision to instil calm and the market recovered to an extent.

Emerging markets, including China, have had a bit of a challenging run but are holding up better amid the volatility.

In summary, across world markets, volatility has increased and many expect it to remain increased for the rest of the year.

Volatility and risk

It is an important time to restate the difference between volatility and risk. Volatility is how much prices move- up or down- from one day to the next. A degree of volatility is ‘normal’ or acceptable. When volatility is higher, the question to ask yourself is whether your investment remains aligned to your long term goals.

Risk is different. Risk is the chance of absolute loss.  This is different from volatility. Volatility means your investment may be worth more or less than yesterday, but that the fundamentals that underpin the investment remain unchanged. Risk means your investment could reduce to zero and not be worth anything in the future. It is important to understand the difference between the two.

Principles

When markets are volatile it is normal to feel anxious, which is why knowing the difference between volatility and risk is so important.

The next principle is to remain goal focused. If you are running a marathon at the Olympics it is not so important what your 100m sprint time is. It is the same for investing. If your timeframe is 10 years, for example, it doesn’t matter what happens within one month. This comes with the caveat that core investment fundamentals remain sound and acknowledges tactical adjustments across market cycles.

More importantly, it reinforces that one should not react against moves that have already happened, and one should also not try and time the market. As has been stated many times, there have been many investors that have lost a lot more money trying to time a market, than those that have sat through a market downturn (and recovery).

Time and volatility

The one key factor that reduces volatility is time. We showed this in a graph in a recent article and we show it here again. Time reduces volatility and the likelihood of a negative return.

If your timeframe is long term, focus on the long term.

Notwithstanding all the above, and with all the knowledge in the world, it is not unusual to feel anxious about markets that are more volatile than normal. We believe the best thing you can do is speak with a professional, like the team at Extended Investments Limited.

If you are concerned about what is going on in the markets, or if you know someone that is worried, whether you are a client or not, reach out to us at info@extinvestments.com and we will be happy to discuss your concerns, your situation, and your goals, and provide useful and prudent advice.