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No Need to Panic During Volatile Markets

Travis Schindler
Partner & Wealth Adviser
19 Aug 2024

It has been a wild few weeks for the Australian and global share market. The huge falls on the ASX that occurred on the first Friday and Monday of August, as well as on Wall Street, may have made investors nervous. But after the share market experienced its worst two days of trade since 2020, the market showed signs of a comeback after realising it may have overreacted to the downside.

What’s causing the share market volatility?
Recent developments in the U.S. suggested that recession probabilities may be higher than the market had priced in a couple of weeks ago. Inflation data released in July showed signs of softening and bolstered the view that the Federal Reserve would reduce interest rates in September. Then, a run of weaker than expected economic data prompted markets to question the consensus view of a soft landing for the economy. Nonfarm payrolls data showed that the economy created fewer jobs than expected in July, and the US unemployment rate jumped unexpectedly to 4.3% from 4.1%. Meanwhile, the Institute for Supply Management’s (ISM’s) gauge of manufacturing activity fell to its lowest level since last November. These signs of weakness in the U.S. economy forced the market to consider the possibility that the Fed could be behind the curve and would need to ease monetary policy potentially faster than expected. This possibility, combined with the Bank of Japan increasing rates, caused Japan’s stock market to plunge 12% on Monday, August 5 – its worst day in 37 years!

It is not all bad news
Technical factors, such as excess optimism in markets that built up before the sell off, seem to be behind a lot of the market volatility. It is important to also remember that not all economic data has been concerning. U.S. gross domestic product surprised to the upside in the second quarter, while the latest reading of ISM’s measure of activity in the services side of the economy remained at levels that indicate expansion. Fast forward a few days and stocks climbed with the S&P500 notching up its best day since 2022 after new labour market data boosted investor confidence in the US economy. At the time of writing this mid-month, headlines read ‘ASX to rise for a sixth day as US retail data ignites global rally’.

With this backdrop in mind and for those understandably feeling uneasy during periods of elevated volatility, it is important to focus on what you can control. Hewison Private Wealth’s principles for investing success are time tested.

1. No need to hit the panic button
While it can be tempting to react when market volatility strikes, the best days can be clustered around some of the worst days and trying to make timing decisions on the worst day could lead to missing out on the best day. Picking the bottom in a market correction is extremely difficult. Given the outsized returns, both up and down, for markets during these inflection points, missing the bottom by even a few days can prove extremely costly to returns. It pays to stay fully invested. The 20 best trading days for the S&P 500 over the last 50 years have provided a compound return of 287%. Finessing the timing of market entry or panic selling and remaining on the sidelines can risk missing these best days and leave the portfolio return lagging that of a fully invested portfolio.

2. Long-term investment horizon
It’s important to keep in mind that an investment in equities requires a long investment horizon. A longer horizon reduces the chance of a negative return over that horizon. Long horizons produce less negative returns.

3. Diversify
Diversifying across regions and sectors reduces the chance of a portfolio drawdown. Diversification is the key to managing investment risk and aims to reduce the risk of one or more investments in a portfolio of having a period of poor performance, as other investments in the portfolio will likely be doing well to make up for the ones that may be having a weak period.

4. Asset allocation is key
Numerous academic studies have consistently shown asset allocation to be responsible for approximately 90% of returns for a portfolio, rather than investment selection. Constructing a portfolio with the right asset classes in appropriate proportions to align with your specific needs and goals is key to navigating volatile markets and overall long-term investment success.