Market Outlook - Volatility Explained

Hey everyone, welcome. This is a special edition of We're Talking Money, specifically to talk about recent market volatility, and we felt like it was appropriate to share our thoughts since it's really hard to get to everyone by phone. This video will answer a lot of your questions, certainly will give you insight to how we're feeling about the markets. So joining me today is Roger Fuller, our senior portfolio manager.

Roger: It's good to be here, and I think this is a great time into getting to talk to the clients, kind of let them know what we're thinking, what our strategies are moving forward, and like Phil said, hopefully answer a lot of your questions.

Yeah, I'll start by saying we're living in a new world of volatility for the last few years actually. Roger, we've seen volatility get certainly more pronounced. If you go back just a decade, say the middle of the last decade, we had a VIX, or a volatility index, that was averaging around, say, the mid teens. That's a very comfortable range, and for our clients, most of them would recognize that as a place where markets can rise very easily.

Today, though, with things like COVID-19, for example, in 2020 that led to a big spike on the VIX. VIX went up to an average of 29, so almost double where it was living for that last decade, right, roughly. 2021, we saw that come down again to a more reasonable range, averaging something closer to 20. Nevertheless, VIX volatility is telling us now that once again we're back into a volatile period.

So to put this in perspective, though, Roger, that VIX index reached 85, huge number, at the beginning of COVID.

Right, right.

What are your thoughts about the VIX? How do you feel these things are helping us to deliver better portfolio performance?

VIX is telling us that there's fear somewhere in the market, absolutely, and there are times where you expect the VIX to be high. What we're seeing now, though, is the VIX increasing without really the obvious outside factors, the dramas, if you will, or traumas. So what you're seeing is an average of the VIX going up based on just market volatility and some fear in the market.

But to put in perspective, since 1920, I did a little research in our charts, and the S&P 500 has recorded a five percent pullback three times a year on average and a ten percent correction once every year and a half.

So we've said many times over the last year or two that stocks have been priced for perfection. There's no question about that, well above fair value. And so this current sell-off, frankly, it really shouldn't come as a surprise. Rather, it is more of a question of how will equities respond to things like rising interest rates, which you just mentioned, and a slowdown in corporate profits, potentially anyway.

So I think maybe let's focus on the technical indicators and try to better understand what's the undercurrent, where are we likely to head next. The first thing that we look at is, one of the first things is momentum. So we use our relative strength indicator for that, Roger.

And in terms of where the next support would come based on that relative strength, frankly speaking, it looks like we're getting close to oversold. So theoretically there would be a bounce somewhere close that. The question, though, is not whether we get a little bit of a bounce, it's will the bounce hold. The sustaining that bounce is what we need to see.

If we get a little bit of a bounce here but we still have a negative trend after that and then again go through some of those support levels, that's where I think we could be in a technical issue where we may see a bigger downfall. So I think the next few weeks will be critical on seeing if we do get a rebound, and can we sustain that rebound.

So if we don't sustain the rebound, then we would likely refer to that as just simply that, a bounce, and then that bounce would likely be met with more selling.

Let's add a little more now to the perspective. So sentiment. People say, well, okay, you got this momentum, maybe we're oversold, maybe we get a bounce. What else helps us better understand which direction the market is potentially heading? And so decidedly at the moment, based on sentiment indicators, is bearish, correct?

Correct. There's more bears out there right now than there are bulls, and—

But isn't that a prerequisite for identifying a bottom after a major sell-off, for a correction? We really need that, right?

Sell-offs are not always a bad thing. They're needed. A market cannot go straight up. So when you get a sell-off like this, you'll get some of the, as we like to call them, the day traders or the novice to sell and get out of the market. And then when we start seeing that drop and more people get bearish, it gets to the point where, okay, now we gotta go against the grind here. If everybody's getting bearish, now's the time to get bullish.

This is one of those classic signals where you begin to see a change. So once you get enough bears pulling the market into sort of a tug of war that we've been into, or that we've been in, and now it's decidedly bearish. But that's generally, you can't find a market bottom until you get enough bears on board, and then eventually we get to a point where the bulls are willing to step in.

Let's not forget, since the beginning of COVID or shortly thereafter, we've been up 90 on the S&P 500, maybe 100.

Exactly. So to think that a sell-off is impossible, in my opinion, would that be pretty naive?

Exactly. I think it wasn't only, obviously not impossible, but it's also due and expected. And so, well, you said it a few minutes ago, it's healthy.

Yes. And from our perspective, you need some kind of pullback or corrective selling to give markets time to digest what's going on. And so let's look at all these things. We have momentum that's bearish, we have sentiment that's bearish, we have a VIX indicator that is bearish, and pretty much everything is bearish at the moment. Generally when we get into these cyclical style bear markets, they last one to three months.

Correct.

So maybe worst case here is we might have a few months, but I'm not even sure if it makes sense to try to talk about when it ends. I think what's more important is what do we do to give our clients a little more confidence. Keep in mind, in 2021 we went through a reopening of our economy. And so to go through that last year, not only were stocks priced for perfection, but they rallied based on this reopening effect, and I think we're still feeling some of that. I think the fundamentals are still in place, but it is going to come to an end. And so now we've got the federal government, or the Federal Reserve, starting to tighten. For the market to take a breather right now really is not, should not be considered unusual.

No, not at all. Really should be considered normal. Let's not also forget that that reopening was a cause for the inflation. Demand skyrocketed, supply was not able to keep up with that, which drove up a lot of the prices of cost of goods, which of course drove up the prices at the store.

True. And so unlike any other time in the past where we've had high inflation, most of that time has been caused by stagnation, not by growth. What I am willing to say with confidence is stock prices, typically they fall more quickly than they rise.

Right.

And our clients likely know that, they've experienced that. We don't want you to think that having some anxiety is not normal. It is. But what's more important than being so fearful of what's going on is trying to put it in context. Now let's get specific as to why. So bull markets are slower to get back on track, bear moves tend to happen quickly. Our investors, our clients are more interested in the speed of recovery.

Right.

So let me just read a few points that I made here for us to think about, Roger, and then I'd love for you to run with these. So during market declines, we often go to something called Fibonacci retracements. So we use those a lot on the technical side, and basically the percentage of declines based on an advance is how we measure that. We're just trying to discern what is the potential sell-off. Well, we've talked about the sell-off being as much as 30 percent, and ideally it's probably more like 10 to 15 percent.

I think the biggest part of this is knowing what declines are possible and then how do we defend against it. For example, the markets year-to-date, at least this morning, we were down about 11 12 percent. One thing we got to remember about the market declines: one, it is just that, it's just the equities portion that we're looking at to the S&P. When you see that decline or the Nasdaq decline, it's driven by a handful of stocks. Even though the majority of the S&P 500 was down today, the decline was more so in the technology stocks than they were across the board.

And really the tech sector is what's led us into this sell-off in the first place. And in fact, the rate of change on the QQQ, or the Nasdaq, it's been around 10 10 and a half 11 actually, as of this morning.

Right. It certainly preempted, or I should say was the prelude to this sell-off. It started several weeks ago, and just like technology brought the S&P up, it's now dragging it down.

Yeah, which is why we always focus, one, just on planning with clients, two, going through all these scenarios, so we can be better prepared for when things like this happen. Our portfolios and our clients are not the market. They are an invested, diversified portfolio that is designed for this, and we've planned on these type of returns.

And let's also not forget, we've been so used to the market rising over the last few years, a 10 percent sell off as we've seen in the last five, six days, that probably feels much worse than it would feel if we were in a more normalized economy.

Correct. Any time we've had a 20 year, the following year rarely gets through its 12 months without seeing a 10 percent pullback.

Correct. In most ways this is quite normal. Here's another piece of encouraging information. When the market does this after a year of 20 plus percent gains, which we had in 2021, it generally recovers. So this loss that we've seen, it generally recovers that by the end of the year. Likely it won't be any worse than flat. That's very encouraging when you're thinking about, oh my goodness, what am I going to lose.

Real quick, Roger, let's talk about just a few more points that could be causing some of this. So one is the ongoing crisis in Ukraine. We also had a Federal Open Market Committee meeting, or the FOMC, so our Federal Reserve was meeting today, and there's statements about Chairman Powell talking about raising rates. But just the thought of the Federal Reserve stopping or halting stimulus and beginning to raise rates, you see some of the result.

Correct, that. So, and I think a lot of the raising rates is not unexpected, and I think a lot of the tone is scaring people, but the tone in reality may be two different things. This is an election year coming up. They don't want to look bad going into the election. They don't want this market down 30 in November when elections come around. So when they've raised interest rates, I think they'll do it at a slower pace than what people may think, or fear I should say. And if that's the case, they can make adjustments along the way.

While the Fed may be moving their rate, the real rate, it's still going to stay low. The real rate is going to stay low. We're still going to have an accommodative Fed, and I think probably around the globe it's going to be fairly accommodative. Like you said, they're not going to do anything, certainly not in a deliberate way, so as to throw us into a recession. I don't believe that. These bouts in the market, these are potentially opportunities to buy, and we're going to be looking at that.

Here's what I mean by that. In this environment, regardless of the sell-off, we're still supportive of stocks over bonds. Investing is long-term. Our strategies are designed for long-term investors, and we're always attempting to deliver higher risk adjusted returns, meaning better performance, lower risk.

Correct. It's not to say to outpace the market, but one thing that I love to talk about is when the markets go down, we tend to do better. Going up in an up market should be relatively easy. Keeping more of what you've earned, meaning having less exposure in the down markets, I've always believed that was more important, and I think we do a nice job of that.

Yes. If our upsides maybe are not quite as much as S&P, but our downsides are a lot less, I'll take that any market cycle out there. Generally across all of our strategies, institutional, growth and income, double ten, you name it, one of the things that I believe separates us from the pack is in the down markets we do so much better. We typically beat the markets 50 60 percent of the time in down markets.

And so as we navigate the current volatility, here's what our investment committee is doing. Correct me on these if I'm wrong, Roger. We're trimming bonds. We don't like treasuries very much. Certainly we want to stay on the short end of the curve, but trimming bonds to raise cash. The other one is what you always say, it's avoiding the knee-jerk reactions. You want to talk about that?

Exactly. So in markets like this, and we've already gotten, like said, a couple phone calls, and of course we got plenty of them back when COVID hit.

Yeah.

And the knee-jerk reaction, meaning when you see these markets go down, you get fearful. And again, that's one thing I want to look at too. Don't base your return on the market, because we're doing a lot, we're going down a lot less than the market is.

True. Fundamentals always tell us what to buy. The technicals help us know when to buy them, and sometimes when to sell them. But when we sell them, we're not selling them to raise cash, we're selling them because maybe there's another stock that we like better. We share with our clients a number of probability studies to help you better understand if your portfolio is set properly to endure these kinds of things. Every client has a certain index that we're trying to accomplish for them so they can reach their goals.

There's no reason to have a knee-jerk reaction if your lifestyle isn't changing, and I think that's really important. And we've talked to a lot of clients about this, is what's the difference between risk tolerance and risk capacity. Risk tolerance, again, is kind of what keeps you up at night, but that's not always the true story. A 10 downturn in your portfolio may keep you up at night, but that's where the planning comes in, where we know a 10 percent downturn in your portfolio is not going to change your lifestyle. So your capacity for that 10 decline in your portfolio may be very easy. Nobody likes to see their portfolio go down.

So what are we doing? Like you said, we're trimming some bonds to raise cash. We're avoiding the knee-jerk reaction. With that being said, that doesn't mean we're not making changes. We're also rebalancing our portfolios to stay consistent with what our strategies are, meaning some of the stocks that we've had that have not sold off as much, or we have big gains in, we may be trimming some of those to go in some of the stocks that have gotten beaten up a little bit.

As one of your advisors, as someone who is here in the weeds every day, we get what you're dealing with. We understand it. But we also want you to know that we're here, we're watching, we've tested these strategies, we've tested the scenarios that we know should give you the confidence to say that you're going to get through this. And maybe most importantly, keep in mind, we do better when you do better. The way our fee structure is built, our performance, meaning how well you're doing, absolutely drives how well we're doing. But it's very important to us, just like it is to you, that we're doing the very best that we can for our clients every day.

Absolutely. I think that is a pretty good overview of where we are. We're coming through some serious bouts of volatility, but by a long shot we don't feel like the bull market is necessarily over. But we do think it's a respectable, or rather a reasonable pause that should have been expected. It's not a surprise by any means. It's healthy for the market. It's never fun to watch. If anybody has questions, that they want to go over their portfolios, please don't ever hesitate to give me a call. I'll be happy to go through it with you. Also our new market perspective will be going out in the next few days as well. Keep an eye out for that.

Please keep in mind, if you have questions, as Roger said, don't hesitate to call us. We're more than happy to take your call, more than happy to meet, talk about things and reassure you that you're okay, run additional scenarios or run additional tests if it would make you feel a little more comfortable. And after all, that's what we want, is for you to be comfortable and confident. We're doing everything possible to help you achieve the success that you deserve and desire.

Absolutely. Appreciate you, your time. Appreciate you as putting your trust into us. Hope you have a wonderful week.

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