Volatility on the Rise — Steps to Help You Cope

How quickly emotions can swing from euphoria to despair. Year-to-date through April 23 (the stock market’s recent peak), the S&P 500 was up 9.2%, the S&P MidCap 400 had gained 16.9% and the S&P SmallCap 600 was up 18.6%.1 But as if to remind us that some things are just too good to be true, the markets began to unravel as April came to a close.


May’s Downhill Slide

First came the May 6 “flash crash” a one-day event that resulted in a 9.6% intraday swing in a handful of U.S. stocks. In many ways, the events of May 6 also served as a harbinger of the bumpy ride that investors would experience in the weeks ahead. By May 31, although all three U.S. benchmark indices were higher for the year, large-cap stocks had fallen 10.5% from their April 23 high, while mid-cap and small-cap stocks had declined about 10% respectively.1,2 Indeed volatility is once again dominating the markets, but how long might it stay this time?

Once Burned, Twice Shy

For their part it seems that investors—recently burned by the swiftness of price declines in 2008—have adopted the approach of selling first and asking questions later. And it is that investor sentiment that is fueling market turbulence. Indeed the number of days that the S&P 500 has fallen by 2% or more in a single day has begun to escalate. In the past 12 months (ended May 31), the S&P 500 has fallen by 2% or more 13 times vs. an average of seven times per year since 1970.3

The question now on everyone’s mind is whether the volatility currently roiling the world’s financial markets will subside any time soon, and how it might affect the fragile, but tangible, recovery taking hold both here in the United States and around the globe.

While world equity markets have weathered past financial crises with only modest near-term price declines, today’s concerns seem to be deeper and more widespread: the European debt crisis and the declining euro; the crisis unfolding daily around the Gulf oil spill; and tensions brewing between North and South Korea.

However, while the current bout of market volatility is expected to be with us for some time, it is not expected to cause either the U.S. economy or the global economy to slip back into recession. Economists at Standard & Poor’s forecast real GDP growth of 3.3% for the United States and global GDP growth of 3.7% in 2010.4

Keeping It All in Perspective

Instead of reacting hastily to the market’s short-term swings, try to take a long-term view and keep the following strategies/perspectives in mind.

• Don’t panic - Don’t sell into a rapidly declining market and don’t buy into a rapidly rising market. You’ll just be following the herd and locking in losses. Panic selling also runs the risk of missing the market’s best-performing days. You never know when the market is going to shoot up, so staying invested and not giving in to panic can really make a difference.

• Review your goals, risk tolerance and investment mix - Does your portfolio’s asset allocation—your mix of stocks, bonds and cash equivalents—accurately reflect your needs? Have you adequately diversified by spreading your money among different investments to potentially reduce risk?

• Keep a long-term perspective - If you are a long-term investor, chances are you have experienced many steep climbs and a few steep drops, but overall you are making progress toward your investment goals. Be sure to ask yourself these key questions: What is your time horizon? How much can you afford to lose in the short term? Can you afford not to pursue growth to outpace inflation? How comfortable are you accepting short-term losses to eventually get long-term gains?

• Dollar cost averaging - If you are a long-term investor, dollar cost averaging can help reduce market-timing risk. By investing regular amounts at regular intervals, your cost per share will average out over time. If you believe that the market will rise over the long term, then the expensive shares you buy at the top of one cycle will be offset by the cheaper shares you buy when the market corrects.

1, 3, 4Source: Standard & Poor’s, The Outlook, May 26, 2010. The S&P 500 is a capitalization-weighted index that measures the performance of 500 large-cap U.S. stocks with capitalizations of more than $3.5 billion, chosen for market size, liquidity and sector; the S&P MidCap 400 is a capitalization-weighted index that measures the performance of 400 midcap U.S. stocks with market capitalizations between $850 million and $3.8 billion, chosen for market size, liquidity and sector; the S&P SmallCap 600 is a capitalization-weighted index that measures the performance of 600 small-cap U.S. stocks with market capitalizations between $250 million and $1.2 billion, chosen for market size, liquidity and sector. Indices are unmanaged and cannot be invested into directly. Past performance is no guarantee of future results.

2Source: Standard & Poor’s Financial Communications. For the period indicated. Past performance is no guarantee of future results.

Consult your financial advisor or me if you have any questions.