Market Volatility Returns
Volatility returned with a vengeance this past week, interrupting what has otherwise been an impressive first seven months of the year for global stocks. Worldwide markets have fallen 5% since the beginning of August as investors sold out of equities and moved into the safety of bonds. What is causing this volatility? Will it impact the economy and the market going forward? And what does it mean for your portfolio?
What is causing the market volatility?
There are two primary reasons for the recent sell-off. The first is the re-escalation of trade tensions between the U.S. and China. China’s sudden decision earlier this week to devalue its currency put the yuan at its cheapest level relative to the U.S. dollar since 2008. Although this move was viewed as retaliation to the announcement of tariffs on up to $300 billion of Chinese exports beginning September 1, the Chinese government insisted the devaluation was more about stimulating its own economy than about trade. Nevertheless, the fall in the yuan reignited tensions between the two economic superpowers. China has since backed off a bit, allowing the yuan to regain some of its value versus the dollar.
The second reason for the sell-off was tumbling bond yields across the globe. Three central banks (New Zealand, India, and Thailand) unexpectedly and aggressively cut rates. This followed the Federal Reserve’s well-anticipated 0.25% rate cut last week. The 10-year Treasury yield briefly fell below 1.6% and less than the 3-month Treasury yield. While this is not the first time this year that the yield curve has inverted (short-term rates higher than long-term rates), the fall in yields in the U.S. and around the world has investors concerned about a global economic slowdown.
Will the sell-off affect the markets and the economy going forward?
It’s hard to say. In the U.S., GDP is still growing, and the current economic expansion is in its record eleventh year. Earnings growth has slowed but companies are still making money. The job market is strong and with the recent cut in interest rates, conditions remain favorable for continued economic growth. As for the markets, prior to this past week’s sell-off, stocks were not overly expensive. So, after a 5% pull-back, stocks are now cheaper than before. Of course, if the trade tensions between the U.S. and China continue to escalate, U.S. and global economic growth, and global markets could be negatively affected longer-term.
What does this mean for your portfolio?
Keep in mind that volatility is a normal market occurrence. Pull-backs of 5%+ are quite common. In fact, the stock market averages a 10% decline every year. So, volatility, while it can be unsettling, is not out of the ordinary. It also creates an opportunity to rebalance to take advantage of the fall in stock prices. This could mean rebalancing between different asset classes in your stock portfolio or rebalancing between stocks and bonds. We review your portfolio every two weeks for rebalancing opportunities.
Also, when volatility hits, bonds are there to cushion the blow. This year has been fantastic for bonds as well as stocks. And, the recent changes to your bond strategy increased the allocation to bonds that are high quality and less correlated to stocks. This was intended to make your bonds behave more like bonds, especially when the stock market drops. Over the past week, we’ve seen exactly that as your bonds have rallied while stocks have fallen.
Finally, it’s important to focus on the longer-term. That’s where your financial plan comes in. Your plan is built to incorporate market volatility. And, your plan is dynamic in that it updates each day. You can view your plan through the MyBDF website or through the mobile app. Your plan, rather than the daily swings in the market, is the best measure of your success.
If you have any questions, we encourage you to reach out to your BDF team to discuss your customized plan and the impact of these market moves.
Matthew S. Reznik, CPA, MBA, CFP®, CFA is a Wealth Manager at BDF. As a member of the Investment Committee, he is instrumental in developing BDF’s overall investment strategy. Matt also enjoys writing and is responsible for much of BDF’s client correspondence. Matt received his Bachelor of Science in Economics with concentrations in accounting and finance from the Wharton School of the University of Pennsylvania and his MBA in finance and strategic management from the University of Chicago Booth School of Business. He is a member of the American Institute of Certified Public Accountants, the CFA Institute, and the CFA Society of Chicago.