The stock market’s sustained rally since the March 23 lows had many investors feeling good about the recovery. The stock market climbed back to new highs as the pandemic’s threat to economic growth moderated, and investors started looking ahead to next year when corporate earnings might recover in earnest.

Then the volatility arrived.

Two weeks ago, the Nasdaq recorded its worst week since the bear market, led lower by some of the biggest names in Tech. The S&P 500 ended that week -2.3% lower, with the Nasdaq dropping -4%. Last week saw a continuation of the selling pressure, with global stocks recording their first back-to-back weekly decline since March.1 Investors seemed worried that Congress would not come to an agreement regarding more fiscal stimulus.

I expect the volatility to continue in the coming weeks – which to me means the likelihood of investor missteps will also go up. The investment community tends to view volatility as an opportunity to take gains off the table, to trade in-and-out of stocks in an effort to ‘buy the dip,’ or in some cases, as a reason to avoid investing in stocks altogether. But I think these approaches tend to result in mistakes – which can ultimately detract from long-term returns.

Take the approaches of trading in-and-out of stocks to either generate profits or to buy stocks that have pulled back. Even though market volatility often presents itself as an opportunity to make some strategic changes, investors often forget that volatility works both ways (up and down), is very unpredictable, and often happens in clusters. Selling pressure one week may not mean selling pressure the next, and investors can get caught waiting for a trade that never materializes.

The desire to take advantage of volatility and to time the market is one of the main reasons the average investor underperforms over time, in my view. Below you can see the 20-year (1999-2019) annualized returns by asset class. According to the research firm Dalbar, the average investor is near the bottom of the return spectrum. Bad timing decisions are largely to blame, in my view.

20-Year Annualized Returns by Asset Class (1999-2019)

 

Source: JP Morgan2

One key thing that investors must remember is that there are two sides to every trade. Any time you make a decision to buy or sell a stock – particularly if you’re basing your decision on a gut feeling or as an emotional response to volatility – there is some trader, money manager, or institution on the other side of the trade that may have better information than you. Timing the market based on limited information or an emotional response is like playing a golf match against Tiger Woods. Over the course of the 18-hole match, you might hit a few better shots than him, and maybe even get a better score on a couple of holes. But long-term, there is basically zero chance of winning.

Another potential reaction to volatility is deciding to go to cash and wait on the sidelines, or to perhaps hold off on investing any new dollars in the market. But this approach is just another form of market timing – the investor is assuming that the market will keep going down and he/she will buy just at the right time. The reality: the time spent waiting is time out of the market, which over the long-term, tends to work against investors.

Bottom Line for Investors

With the election fast approaching and uncertainty about the growth trajectory of the U.S. economy, I expect volatility to continue apace in the coming months. Looking back at the last seven U.S. presidential elections, the CBOE Volatility Index (VIX) has risen an average of approximately four points in the month leading up election day.3 Investors should reasonably expect some bumpiness this time around, too.

With increased volatility tends to come increased desire to “do something,” or to make changes or trades in investment portfolios. But doing so tends to lead to more mistakes, in my view, which can ultimately detract from long-term returns.

Disclosure

1 Silverlight Asset Management, September 11, 2020 https://www.silverlightinvest.com/blog/5-things-we-learned-week-0

2 J.P. Morgan, August 31, 2020. https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets/viewer

3 The Wall Street Journal. January 22, 2020. https://www.wsj.com/articles/options-markets-brace-for-election-volatility-11579694401

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