| Market Commentary - 12.15.14 Investors Deal with Heightened Market Volatility Simply put, market volatility refers to the measurement of presently known expectations of return movements within an uncertain world. Within the U.S. securities, volatility is most widely measured by the CBOE Volatility Index (VIX) in context to the S&P 500 and is considered the best barometer of investor sentiment. Put another way, the index is a “fear factorâ€쳌 reflection of investors' views of current market conditions and their near-term outlook. Last week, the VIX Volatility Index soared over 78% to 21.08. Putting the current VIX level into context, the index had leapt 15% to 26.25 on the day the S&P 500 had most recently troughed on October 15th. We should note that by historical standards, the under 10% volatility average for the last several years is on the low side, and the markets may move closer to the 14%-15% volatility average we have experienced over the last 10-15 year period. Let's understand and put extraordinary large moves like this into perspective and focus on ways to possibly reduce portfolio risks due to volatility.
Let's consider these moves last week: - The Dow Jones Industrial Average lost 315.51 points (-1.79%) on Friday to cap the week with its worst performance in three years, shedding 677.96 points (-3.78%). Year-to-date, the Dow is up 6.69%, including dividends.
- Likewise, the S&P 500 retreated exactly 33 points (-1.62%) on Friday, completing the week down 73.04 points (-3.52%) for its worst week in two and a half years. The benchmark index is still up 10.48% YTD, including dividends.
Yet on the day we learn this dismal performance, the University of Michigan said its preliminary reading of consumer confidence for December rose to 93.8, its highest level since January 2007. The present dichotomy between market performance and consumer sentiment is largely due to this year's plunge in crude oil prices, down nearly 41% year-to-date (off over 12% last week). Consumers are enjoying lower gasoline prices, boosting disposable income, while global energy-producers' profits are challenged. Keep in mind that energy-related companies represent a significant portion of the S&P 500's earnings, so their weaker profits are causing investors that focus on profit growth and valuations a little uneasiness. Courtesy of the boom in U.S. shale oil and gas extraction, the era of expensive oil may be ending, at least for the near to mid-term time frame.
Other catalysts behind increased market volatility include prospects for higher U.S. interest rates next year, the slowdown in European and emerging markets manufacturing, including China and Brazil, and the uncertainties of when their central banks may provide needed stimulus, as well as geopolitical risks associated with both Islamic extremism and the Ukraine/Russia territorial conflict.
Based on recent moves in the VIX, it is clear that market volatility is on an upswing. While the VIX index is commonly referred to as the “fear index,â€쳌 you should not necessarily fear volatility in your portfolios. Dollar-cost averaging in market fluctuations may allow you to take advantage of lower equity prices on new purchases. Allocations to fixed income investments and more traditional dividend-paying stocks also help mitigate portfolio movements as a portion of their returns is derived through ongoing income streams.
Though we still believe U.S. financial markets are on a solid foundation, volatility is likely to remain elevated and portfolios should be positioned accordingly. Beyond favoring developed markets, which also stand to benefit from global stimuli, a slight overweight in growth over value in stocks, and less interest rate sensitivity in fixed income, we continue to urge greater portfolio diversification to brace against volatility. This includes an allocation to investments such as alternative strategies, commodities, and REITs, which have demonstrated low correlation to traditional investments like stocks and bonds, and will tend to mitigate the effect of equity price fluctuations on your broader portfolio. This information is compiled by Cetera Investment Management.
About Cetera Investment Management
Cetera Investment Management LLC provides passive and actively managed portfolios across five traditional risk tolerance profiles to the clients of financial advisors, who are affiliated with its family of broker-dealers and registered investment advisers. Cetera Investment Management is part of Cetera Financial Group, Inc., which includes Cetera Advisors LLC, Cetera Advisor Networks LLC, Cetera Financial Specialists LLC, and Cetera Investment Services LLC.
About Cetera Financial Group
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No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The opinions expressed are as of the date published and may change without notice. Any forward-looking statements are based on assumptions, may not materialize, and are subject to revision.
All economic and performance information is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot directly invest in unmanaged indices. Please consult your financial advisor for more information.
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