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Understanding Recent Market Volatility | Fisher Investments

Understanding Recent Market Volatility | Fisher Investments

I’m Erik Renaud, a Group Vice President in
our Private Client Services Division, and I’m joined by Investment Policy Committee
member, Michael Hanson. Hi Erik. Hello Michael. We’re going to talk a little bit more today
about volatility, and what it might mean for all of you as investors. 2017 was an exceptionally low volatility year. Should we be expecting more of the same in
2018? You know volatility is one of these things
that it comes along with being a stock investor. It’s most pronounced with stocks in most cases. Other asset classes tend to be a little less
volatile, don’t change as much. But with stocks, volatility is part of the
standard. But, going along with that, volatility is
completely random. If there was a way to say, “Well we’ve had
low volatility, “now we’re going to have high volatility.” Or, low volatility means this for the stock
market, and high volatility means that for the stock market. We wouldn’t really have to do much else in
forecasting. We could just make our bets and go home, and
all of us could be billionaires. But unfortunately it doesn’t work like that. Volatility is almost perfectly random within
the stock market. And as a result, that’s why it’s so challenging
in many ways to deal with, because what volatility really does, and the way I think of it, is
it’s sort of the price that people have to pay in order to get the long term return of
stocks. And that’s a psychological price. It’s a price that, you know when folks are
sitting at home, whether they’re retired, or just looking at their investments, they
go online and they look at their screens, and they see things on a short term basis
jumping around so much. It causes a huge amount of emotion. But the truth is, when you start thinking
five, 10, 15 years into the future, volatility matters a lot less than people actually think,
and as a matter of fact stocks are a lot less volatile if they’re consistently positive. It’s just that in the short term the wiggles
make people nervous, and it gets people off of their long term discipline and plan. So if discipline is the prescription during
a correction, how does that differ from what we would do during a bear? Yeah so a bear market by contrast to a correction
is something that’s much longer in duration for one thing. And very different than a correction, it has
a fundamental features behind it, or a sentiment feature behind it that makes the duration
much longer than a correction. But, the way a bear market unfolds is much
different as well. Bear markets don’t announce themselves like
corrections do. Instead, they lull investors to sleep. Most folks are thinking higher, this is an
opportunity. We’re rationalizing a better world in some
way when in fact there’s something fundamental that actually might be brewing. So bear markets roll over, that’s the way
they get more people to do bad things if you want to think about it that way. And they don’t have their real losses until
the end as a matter of fact. There’s a few ways that we think about bear
markets internally that I think that would help everyone to think about bears. We call them the four rules of bear markets,
but they’re not really rules, they’re more like what you would call heuristics. And heuristics is, you know, what you might
say is a rule of thumb. And we say that because this is a probabilities
business, it’s not a certainties business. But these four items can really help. The first one is just what we call basically
the Three-month rule. And the Three-month rule says, if you have
a market peak, do not go defensive or out of the market until three months after that
market top. This gets to my point that bear markets roll
over, they don’t announce themselves. And so the first discipline is to say, if
you’re hitting a new peak, because bull markets don’t have spike tops, you’ve actually got
at least three months to try to understand what’s happening. As things start to roll over, then you can
start to take some defensive action. Which leads me into some of the other rules. The next one is the Two-percent rule. Two-percent rule says bear markets, they’re
going to do this, but on average their trajectory is about two percent per month. And, this is another way of saying the three-month
rule really comes into play. Which is that a bear market’s losses don’t
all happen at the front, they happen towards the end. You’ve got some time, and you can start to
understand and see this trajectory. The third rule is the 2/3rds, 1/3rd rule. This one happens to be my personal favorite
simply because it’s like a mathematical identity, and it’s uncanny how well this works through
virtually all bear markets through history. As a matter of fact, all these rules really
work very well. But this one states that 2/3 of the losses
of a bear happen in the final third of its duration. Which is another way of saying, bear markets
roll over, they tend to have a trajectory that fools a lot of folks and then capitulation
happens at the end. Then the last rule is sort of the bookend
to all of it which is called the 18 month rule. The 18 month rule says that if you’ve gotten
defensive, you’ve gotten out of the market successfully, you saw the bear market, never
be defensive for more than 18 months. Bear markets can last for more than 18 months
but by the time you’ve done the three-month rule, you’ve done 18 months out, that’s 21
months. Not many bear markets last more than that. And as we’ve said to our clients so much through
the years, in order to reach your long term financial goals you need to be in the market,
not out of the market. Being out of the market is the riskiest thing
you can do. The 18 month rule says that even if you think
there might be a little more downside, especially in that very turbulent capitulation part of
the bear, you need to get back into the market because you know at some point soon the market’s
going to move up on you. And when bull markets start, they start quite
violently. They look like a V, and they leave a lot of
folks behind, and that’s the last thing we want to do. All of these disciplines really say, they
have a common theme. Which I touched on already, which is that,
we want to try to get defensive on our client’s behalf. We want to try to do that as successfully
and as often as possible. But the simple fact is, the long term return
of stocks, including bear markets, can get people to their financial goals. Our number one goal is to get people to their
financial goals. These rules are disciplines to disallow us
from getting bearish too soon, getting back in too late and being out for too long. And if you can do those things, and just do
it successfully a few times over the course of a long term time horizon for a client,
I think you can really add a lot of value. So Mike, thank you very much for taking a
little extra time to walk us through our approach to managing downside volatility. And for all of our viewers today, thank you
very much for watching.

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