August 25, 2015 | Understanding the current volatility.
Week in Review
Headlines over the past couple of weeks have been dominated by news of the global equity market sell off. The volatility that began in Asian and emerging markets spread to most developed markets last week.
The S&P 500 closed Monday down 10% from the beginning of the month. Germany's DAX was down over 8%. As of Friday, stock markets in eighteen of the 20 largest world economies (G20) had fallen below their 200 day moving averages (ex. Japan, Russia, etc ).
Contributing factors to the recent decline are:
Part #1: Greece
Earlier this year Greece defaulted on their loan to the International Monetary Fund causing quite a bit of drama in both the news and the markets.
Part #2: China Devalues the Yaun
Just as the markets began to settle into their new routine, and had accepted that the EU would make the Greece problem go away, China brought their economic troubles to the forefront by devaluing the Yaun.
Part #3: A Confusing Fed The final nail came a little over a week later when the minutes from the Feds last meeting (in July) were released. Volatility surrounding pronouncements from the Fed are not unusual. However, in our opinion, when the minutes were released on August 19th it seemed to open the floodgates of fear.
As you can see in the chart below, just as the market were recovering from the devaluation of the Yaun, the release of the Fed's minutes may have been seen by some as a prophetic vision of current events, and almost as one the market panicked.
Our Read on the Markets Moving ForwardIn our experience, very often short‐term fear impulses trump market fundamentals. Fundamentals across the developed markets remain sound. While the emerging markets are susceptible to capital flight, the monetary policy controls, debt levels, currency risk, and fundamental balance sheet strength are significantly better than the emerging market contagion of the late 1990's.
Despite improving economic conditions across developed economies, regional panic‐selling may spillover and result in a significant drawdown of domestic equity prices. We do not deem such market action as a secular event, but rather a healthy cyclical occurrence. From a historical perspective, this is well within the realm of appropriation as 5% pricing corrections occur on average 3.3 times per year, for the last 80 years - with a correction of 10% occurring once every 14‐15 months.
Warning to Investors Near Retirement or RetiredDespite all the positive economic indicators in the US and developed economies, retirees and those soon to be retired, face an extra challenge in volatile markets. In addition to the usual risks associated with investing in the market (loss of capital, liquidity, etc ), those near or currently in retirement face the extra risk of compounding their losses by withdrawing from their retirement savings during times of volatility.
In essence, if an investor withdraws money during a down market, they not only lock in their losses, but they significantly reduce the chances that their assets will ever recover to their initial value. This effect is what's often called "sequence risk."
To protect themselves, it is recommend that retirees and soon-to-be-retirees utilize investment strategies that incorporate downside risk management as a core component of their strategies. By limiting the maximum downside potential for investments and getting out of the markets early enough in a downward trend, and re-entering before the market peaks, an investor can capture reasonable gains while avoiding the majority of the volatility.
At Tradewinds Financial Group, Inc. we only employ strategies that incorporate downside risk management and risk levels that are appropriate for each investor. If you have any questions about your investments, even if you are not a client of Tradewinds Financial Group, Inc. don't hesitate to call (937) 492-6016.