FOR the month of September thus far, US stocks have been on a downward slide, with the S&P 500 Index declining by 200 points, or 5.5 per cent in less than two weeks. This latest market plunge comes against the backdrop of heightened fears of the economic impact of the unabated spread of the coronavirus. Such cycles are common in the stock market, especially in the overseas markets. Investing in equities is not for the faint-hearted as many factors can drive share prices up or down regularly. Investors must not panic, however, and should be prepared to ride the natural highs and lows.
The fluctuation in share prices is known as volatility and is a daily occurrence. The stock market is a broad measure of the economy, thus is affected by a myriad of factors, including inflation, interest rates and geopolitical events.
In the US market, to aid investors to measure volatility, the Chicago Board of Options Exchange created the Volatility Index or VIX. This index is forward looking in nature as it represents the expected movement in the S&P 500 index over the next 30 days and is quoted in percentage points. Given its futuristic poise, the index seeks to capture expected volatility, with a high VIX reading indicating investors anticipate large movements in the stock market.
Strategies to keep your investments on track
Volatility is often misunderstood and feared by most investors. Consequently, investors overreact and panic and subsequently bail out of the market, incurring huge losses. To resist having a knee-jerk reaction, investors must acknowledge that volatility is inherent in investing and accommodate for it. When building an investment portfolio, an effective way to lower the risk of huge swings in investment value is to hold securities in different asset classes, industries and even geographic locations.
Periods of significant fluctuations in share prices should also not be viewed with disdain, but be seen as investing opportunities, creating an opening for investors to purchase stocks with strong fundamentals at affordable prices.
Over the past couple of years, stock markets around the world experienced a bull market, which is a steady rise in share prices and increased buying of stocks. Prior to the Covid-19 pandemic, the Trinidad and Tobago Composite index followed a steady upward momentum, posting gains for the last three consecutive years of 4.7 per cent in 2017, 2.9 per cent in 2018 and 12.7 per cent in 2019. In the US, given the degree of sophistication, the S&P 500 index exhibited more volatility, generating gains in 2017 and 2019, but a 6.2 per cent loss in 2018.
The upward momentum in the stock market has served to provide substantial share price gains. It has also caused share prices to be significantly inflated, leaving many investors on the sidelines. While the pull back in the stock market in March 2020 and ensuing volatility due to the Covid-19 pandemic may have created some anxiety among investors, it is also an opportunity to acquire securities that were previously overpriced, overlooked or overvalued.
Market volatility can also be utilised by investors to rebalance their portfolios. Wild changes in the market can skew a portfolio’s allocation from its original target, with the assets that have gained in value exceeding its intended proportion of the portfolio.
Similarly, securities whose value have declined will account for a lower percentage of investment holdings. The rise and fall of the market facilitates selling positions that have become overweighted and overvalued and purchase the securities which are underweight and undervalued. Rebalancing is essential in achieving the desired portfolio return and it is a good idea to do this regularly.
Volatility tends to make investors feel uncertain and fearful about the future direction of the market. Such fear often leads to rash decisions being made which are ultimately not in investors’ best interests.
History has shown that volatility is often short term in nature, with the stock market following an upward trend over the long term. As such, investors should expect some degree of fluctuations in investment value and should take a more measured response to market volatility.
Source: Trinidad and Tobago Stock Exchange, Bloomberg