How To Game Market Volatility
After only two weeks of 2016, it's safe to say that it's been a bad year for investors. Historically bad, in fact: in 198 years of public trades, no opening week has ever been as dismal as 2016. The Dow Jones lost over 1500 points in just 10 days, effectively erasing three trillion dollars of value from the global market. As with many investment highs and lows over the past decade, the culprit is China. The downright dreadful performance of their nascent stock market, in combination with the devaluation of the yuan, has created an atmosphere where some corporations are facing the prospect of a 1-billion-strong customer base slipping away. With poor performances comes a predictable doom and gloom, along with a rush to get out before it becomes too late. After all, the best position in a downturn is to reduce high-beta investments and concentrate on bonds or T-bills, right? As you may have guessed, the answer is no -- not at all.
Better To Be Lucky Than Good
If optimal returns relied on nothing more than selling off once the market starts to slide, just about everyone on planet Earth could be rich. Instead, the facts suggest that the vast majority of investors (and, for that matter, investment advisors) cannot correctly time the market's fluctuations. Wells Fargo estimates that 90% of all individually-accumulated portfolio growth occurs strategically rather than situationally, suggesting that most investors who attempt to game the market are doing little better than flipping a coin. Market gurus themselves tend to have a rather unflattering record when predicting the market. Case in point, Warren Buffet's advice in 2015 to stick with low-index funds; it turns out that equities and ETFs dominated the market while index funds did only a little better than mutual funds. Since accountability in the investment world matters less than experience, and because investors always look forward and not backward, the next prediction always takes up the conversation. Trying to time the market, as such, is often a mistake, and often an expensive mistake in the event that an investor misses out on the most profitable market swings.
Micro-investing seems tempting. What's the harm with pulling your money off the market for a short period of time -- say a month or less -- to sit out the swings as volatility corrects itself? Consider the basic numbers. A solid 10% growth rate for a portfolio (the average growth rate of the S+P 500 for the post twenty years, including booms and recessions alike) means that your money doubles about every four to five years. Yet the market doesn't always grow incrementally. Wild growth happens no less frequently than wild collapses, as we saw the first weeks of 2016. Missing out on the best ten days of market trading over a 20 year time span, reports JP Morgan Chase, will actually cut growth rate in half, dropping to just six percent. This means that investors who try to buy in and out run a fantastic risk, especially if they hold on for too long. Once an investor misses out on the best thirty days of market trading over a 20 year time span, their growth rate falls to just a percentage and a half, barely better than a money market account or certificate of deposit. Slap on the cost of transactions and Uncle Sam's cut, and it's clear that the market is gaming investors, not the other way around.
With a deck stacked against them, should an investor throw up their hands and stash their money in a mattress? Hardly. Just because there's a serious flaw in timing the market doesn't mean that strategies to eliminate volatility can't be successful. Like all things in life, success on the market requires taking on risk. Bear markets represent excellent opportunities to buy low; current value stocks trading at 52-week lows that will likely rebound after the correction plays out includes historically strong performers like Hyatt Hotels, Bed Bath and Beyond, Papa John's International, CenturyLink, and TreeHouse Foods. Those who haven't the stomach to take on as much risk in their portfolio by adding individual shares of ailing companies have a number of other options available to them. The Vanguard S&P 500 ETF (VOO on the NYSE MKT, trading for $171 a share) mimics the performance of the S&P, allowing investors to snap up shares when Wall Street closes out consecutive days or even weeks in the red, at a bargain-barrel price tag of just .05% per year. The Vanguard ETF should be a major backbone of any portfolio, since it too collects the ~10% average return that the S&P enjoys from year to year (and please note the use of the word "average"). Conversely, the Rydex Inverse S&P 500 Strategy Fund (RYURX on the NYSE MKT, trading for $15.02 a share) allows investors to leverage market volatility and balance their portfolio in bear markets. Just don't hang on to the Rydex for too long -- it has only posted two consecutive months of gains twice since the Great Recession.
- The Takeaway: bear markets come and bull markets go. After a downright mediocre 2015 and a startlingly bad 2016, investors might be afraid that the gains accumulated since the market's 2009 nadir might be on their way out the door. While further corrections could quite realistically lie around the corner, especially if the Chinese market continues to tumble so drastically, investors need to carefully consider buying and selling options instead of simply unloading stocks that have began to trend downwards. Those who want to minimize risk and losses can look to short-term strategy funds to balance their portfolio.
- Look for value during a market correction. There's plenty to be had amongst Fortune 500 companies, and while certain businesses should be off the menu for the near future (most notably energy and mining companies), companies that had a poor holiday season or suffer from management turnover represent ripe opportunities.