Content provided by Joe Smith, CFA, Senior Market Strategist
The first quarter of 2018 has so far seen a bout of market volatility that in some ways is long overdue. At the end of January, markets began to move — falling from slightly positive to near-correction territory by early February. Although much of the sell-off has been attributable to higher interest rates in the U.S., global equity markets have all participated in the decline.
Despite this, I believe investors should not hit the panic button just yet. Why? Below are three simple reasons why market volatility could be a positive development.
- Market volatility is good for active management: Periods generally marked with wider swings in asset prices tend to translate into opportunities for active managers. Although there is no guarantee active managers will always get it right, investors should take note that volatile markets create opportunities to buy securities at modest discounts from previous peak prices.
- Higher volatility creates greater opportunities for diversification: Emerging markets are a great example. Emerging markets hit new highs in terms of the amount of volatility they carry relative to the rest of the world (often described as relative risk). Although this may seem to be a red flag, in many cases it is not. Higher-volatility assets can offer better ways to diversify holdings because they tend to be even less correlated than other assets.
- Market participants can behave irrationally despite no change in the key data: Higher interest rates in the U.S. don’t necessarily indicate the global growth story is in jeopardy. In fact, the amount of liquidity that remains in the markets due to prolonged easy-money policies in Europe and Japan provide some evidence economies can hum along. Investors should keep in mind that bond purchases have kept short-term interest rates in those regions well below zero-bound and sharply negative. Translation: There is still plenty of punch in the bowl for the party to continue.
As we always remind our readers, maintaining a balanced portfolio and sticking to an investment discipline are necessary to withstand the emotional jitters volatility can create. The key is to ensure you can maintain an appropriate level of risk to weather market ups and downs.