Today, uncertainty remains. The U.S. economy, Europe, and the political infighting surrounding the “grand bargain” remain noteworthy question marks. So what can investors expect? Without a crystal ball, no one truly knows. However, we can draw from past experience and intuition to help prepare investors for any potential outcome. One thing we do know is that periods of low volatility (like periods of high volatility) do not last.
Of course, it bears repeating that we have no idea how the markets will react to the next macroevent, positive or negative. However, what we do know is that macroeconomic shocks are nothing new, and each time one has occurred, there has been an accompanying spike in volatility. What’s also true is that once a “shock” has been alleviated, the markets return to more normalized levels. For example, in March 2012, we wrote about how far volatility had declined. Over one 30-day period in March, volatility in the equity market was lower than 78% of periods since 1964.
We also know that ETFs can hardly be the culprit in these periodic spikes in volatility. We have previously shown that ETF trading volume as a percentage of all trading volume in the market historically has been uncorrelated with volatility and that spikes in volatility have occurred when ETF market share was generally on the decline.
How to prepare?
Control what you can control! Investors who maintain a proper allocation to low-cost, diversified stock and bond investments have the best weapons to combat periods of high volatility. Importantly, high-quality fixed income assets can help to mitigate the risks posed by global macroevents on equity holdings. Those investors who have determined an appropriate asset allocation, who employ broad diversification, and who rebalance when necessary have historically weathered periods of excess volatility better than those who don’t.
Fran Kinniry, CFA, is a principal in Vanguard Investment Strategy Group.
I would like to thank my colleagues Chris Philips and Todd Schlanger for their contributions to this blog post. This commentary represents a continuation of the research that we have produced concerning market volatility.