Resources/Weekly Insights

Volume 13, Edition 22 | September 7 - September 13, 2024

Volatility: Friend, Not Foe

Doug Walters, CFA

Volatility can unnerve the best of investors. But volatility is your friend, and evidence-based investors know how to capitalize on that friendship.

Contributed by Doug Walters, David Lemire, Max Berkovich

Last week, US stocks fell around 4%. This week, they reversed that move, sharply rebounding. Welcome to market volatility! Big moves can conjure feelings of anxiety, especially when headlines scream about geopolitical tensions, contentious elections, and economic uncertainty. This week, I aim to demystify volatility and emphasize why it is not only normal but beneficial.

Volatility refers to the degree of variation in prices over time—the day-to-day, minute-by-minute ups and downs of share prices. While potentially unnerving, this turbulence is what makes investing in equities potentially rewarding. Think of volatility as the heartbeat of the financial markets. Without it, there would be no life, opportunity, or returns worth mentioning.

A Sea of Uncertainty

We currently find ourselves amidst many unknowns: the Presidential election, turmoil overseas, the first Federal Reserve rate cut in years, and general economic uncertainty. But let’s be honest; we are always in a state of uncertainty and always will be (until we get that crystal ball up and running). Rather than seeing this uncertainty as a threat, I encourage you to view it as an opportunity.

With Risk Comes Return

Uncertainty equals risk, and risk is fundamentally tied to returns. Assets with higher volatility, like equities, offer the potential for higher returns. In contrast, cash and other low-volatility investments produce comparatively smaller returns. The historical performance of equities demonstrates that despite periods of significant downturns, the long-term trend has been upward, rewarding investors who can stomach the short-term fluctuations.

Harnessing Volatility

Another benefit of volatility is the chance it provides for evidence-based investors like us to take advantage of opportunistic rebalancing on behalf of our clients. This strategy involves systematically selling assets that have performed well and buying those that have underperformed. In essence, it allows us to sell high and buy low. Opportunistic rebalancing is how we unleash the full power of diversification. It gives us the potential to simultaneously boost returns while reducing risk – the holy grail of investing.

The next time market jitters spike, give thanks. A world without market volatility would be a world devoid of excess returns—a monotonous landscape of cash with no growth. No risk, no reward. Market volatility should be seen not as a foe to shy away from but as a friend that offers valuable opportunities. Embrace it. A well-conceived, evidence-based strategy can turn volatility into a powerful ally.

2.6%

CPI Annual Inflation

The latest consumer price inflation print produced the lowest value in three and a half years, and one consistent with the pre-pandemic range.

Headline of the Week

What else… The Fed

Two inflation reports are out this week. The first, the Consumer Price Index (CPI), was largely in line with expectations and was seen as paving the way for Fed rate cuts (starting next week). The second, the Producer Price Index, also met expectations. There was much parsing under the reports’ covers, which rekindled volatility across stock and bond markets before the general trend higher resumed. With the major economic reports out of the way ahead of next week’s Fed meeting, the size of the Fed’s first cut, as well as its second and third, moved to center stage. This Fed sizing exercise likely also contributed to this week’s volatility.

The Week Ahead

Where Do We Begin?

When the Federal Reserve ends its September meeting on Wednesday, the question is not expected to be, “Did they cut?” but “Did they cut enough?”

With all the data on the table, employment, and inflation being the primary data, there is still no consensus on 25 or 50.
It is not as simple as a coin flip; odds are better on ¼ of a percent, but since this is the initial step, would going ½ be a potent message that the central bank is not sleeping on the job and making sure the economy continues to plow ahead?
On the other hand, a ½ percent cut may spook investors into thinking the economy is not as solid as it seems.
Despite the final magnitude, the “dot plots” tracing the path of further cuts and any comments during the press conference are extremely important.

Taking a Hike?

On Friday, the Bank of Japan (BOJ) takes center stage, and unlike most of its developed market peers, it is discussing hikes.

With zero rates now in the rearview, the BOJ must decide if further tightening is necessary.
Moves in rates in Japan cause gyrations in currency markets that spill over into stock markets because of the carry trade.
We have an example of what happened in recent memory, early July, to be more precise.
In July, the US Dollar-Yen exchange rate went from 160 to 150 and is at 140 right now, a direct result of higher rates. In currency markets, those are big moves.

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