I’m sure you’ve asked yourself that question a lot lately. Well, to some degree we live in a new normal paradigm. It’s hard to believe that the first iPhone was introduced on the 29th of June in 2007. The emergence of such technology however has facilitated a world where information is instantly available, and from any number of sources. As technology has evolved, so too have programs that allow professional money managers to instantly trade large blocks of securities through what we know as high frequency trading.
Algorithms are also employed by institutional managers. An Algorithm is merely an “If X then Y” instruction that will execute when triggered. If a stock price hits X dollars, then the program will immediately sell Y number of shares for example. So, being constantly exposed to instant information, on our phones, as we watch the red and green blocks flash by the trade on your Yahoo phone app, and on our computers, tablets, and televisions, while coupled with the mechanics of high frequency and algorithmic trading, can really set a stage for short term worry, angst and fear as markets gyrate by hundreds of points.
Many have asked before if I thought the markets moved “logically”. Actually, I believe the markets do the same thing each and every day. It may not seem logical at the time, but markets constantly reprice risk, and I mean on a second to second basis. Markets are simply responding to changes in assumptions on a constant basis.
Going back to my earlier point about being in a new paradigm, we’ve never experienced an environment within a single tweet could move markets by hundreds of points. On the first of August for example, President Trump tweeted about the imposition of a new 10% tariff on $300 billion of Chinese imports. There was no lead up, forewarning or anticipation of this announcement. Indeed, when the tweet was released, the market was up over 200 points. By the end of the day however, we were down nearly 400 points.
One tweet was the catalyst for a 600 point intra day market swing. It came out of the blue, caught the markets off guard, and immediately the risk of such having an impact on the US economy began to be repriced into valuation assumptions. It’s the world we live in now. And, more than ever before, investors should be much more concerned with long term objectives than short term outcomes.
There are things that can be done to address volatility. For some clients, we employ mechanical measures as we anticipate unforeseen volatility. Through the use of put options for example, we can utilize derivatives to establish a floor under the value of a stock holding. For other clients, it’s the discipline that comes with the dilution of shares. For example, if a client has purchased a stock for $100 per share, and it declines in value to $70 per share, if we remained convicted about our purchase, then my advice would be to purchase additional shares.
If we’re right, and the stock returns to $100 in value, then the original shares have broken even, while the shares purchased at $70 have brought a nice gain to the position, and we have a higher holistic value than had we done nothing. Still for others, it may involve a passive strategy like quarterly rebalancing or dollar cost averaging.
Any mechanical strategy like this must be employed and viewed against the backdrop of economic strength and other market metrics. If over reaction and perception have presented you with a buying opportunity against otherwise strong fundamentals, you must have the intestinal fortitude to take advantage of them.
Managing the emotional aspects of volatility requires a different approach. As we’ve discussed in previous articles, we identify the right investment approach through objective driven planning. When faced with periods of higher volatility, we return to the nexus of our plan and why we took the actions that were taken. Are we still driven by the production of durable income, or are we still driven by the quest for growth?
Sometimes periods of time like this cause us to change our statement of investment selection. At the end of the day, I’m helping to manage the emotional side of volatility by being present, aware, and informed. My job is to rise above the noise of the moment and help clients to remain focused on the long term objective that we’re pursuing. Within my commentary from June, we talked about “if it is to be it is up to me”. Well, if it is to be (that you endure and make periods of volatility work for you) then it is up to you. I’m here to help in that process.
