Volatility has gone away, but it will surely return

By Kevin Fusco

The Daily Record Newswire

The first 12 weeks of 2012 provided the two things that most investors long for -- steady returns and low volatility.

It is in this environment that anxieties are assuaged, risk is re-evaluated, and memories are seemingly shortened. It is also the environment that often signals when changes are afoot, and when investors should be paying close attention to not only what lies ahead, but what lingers.

The low-volatility landscape that has persisted since the end of December has been a welcome change from the hyper-volatility that defined the third quarter of 2011, and as it has continued, investors have slowly, but surely, committed more and more assets to the broad financial markets.

Interestingly, many of the same fears that existed last August remain relatively unchanged. The European debt crisis, while improved, still possesses no firm resolution. The United States' fiscal house is in no better order than it was when Standard & Poor's downgraded Treasurys from AAA status.

And while some of the players have changed since last spring, fresh geopolitical risk can now be found in Iran and Syria, with commodity concerns leading the headlines once again.

As recent returns illustrate though, these concerns have taken a back seat to renewed confidence in the financial markets, with the S&P 500 index gaining more than 8.5 percent through the end of February. Sure, we have seen some pretty solid economic reports of late, and earnings season, while muted, still exceeded expectations, but these facets are nothing new.

Investors who now cling to this data as new accomplishments ignore the progress made since the end of the recession, and just as the aforementioned risks have been ignored, so too were the opportunities that existed over the same time period.

Yet in investing, as with most else, ignorance is not bliss. As is well known, past performance does not guarantee future results, but investors should be carefully examining the market conditions, and reference some historical occurrences, to determine what might lie ahead.

Volatility will make a comeback. The short-term, wide swings encountered over the past four years are anything but extinct, and the financial markets are probably due for a correction, if recent trends are any indication. A correction is a downward move of more than 10 percent, and is calculated from any high point on a continuous, not calendar, basis.

The term correction has a much more negative connotation than what is normally experienced as one of the few constants in the investment world. Statistically, the equity markets experience a correction about once every 12 months. According to historical data derived from Standard & Poor's, once a year, normally accompanied by a spike in volatility, the markets shed more than 10 percent in value, but only once in about every 3-1/2 years will the correction account for more than a 20 percent loss.

Many times the markets -- and investors -- are looking for a catalyst that could trigger such a correction, and now there are more than a few that fit the bill. In addition to the risks outlined earlier, fresh concerns surround commodity prices, global growth estimates recently fell, and a presidential election looms in the near future.

Tensions have recently flared with Iran, and after much saber-rattling and a threat to close the Strait of Hormuz, oil prices have risen to their highest level since last April. Gasoline prices have also increased, which furthers fears that higher fuel costs could stall economic growth. Global growth estimates are already under duress, and increased commodity costs would only serve to hamper growth even further.

Finally, while election years have shown mixed results for the financial markets over the past few decades, the 2012 contest could induce volatility due to what is at stake for both major parties. This election stands to set the stage for one of the largest changes in fiscal policy since the end of World War II, and the markets have already shown to be nervous at previous failures by Congress, the administration and the so-called "super committee."

When volatility does return, investors can take solace in the fact that the negatives do not necessarily cancel out the positives. Domestic growth should continue to strengthen, if not hold steady over the short term, and continued gains in employment are likely. Corporate fundamentals are still relatively strong, and balance sheets are still largely heavy with cash.

These positive undertones should help to provide balance during the more volatile periods.

Investors can help navigate the uncertainty by relying on some strategies that rarely go out of favor. A solid asset allocation framework and adequate diversification are a good start, but proactive rebalancing plays an increasingly important role in effective portfolio management.

No rebalancing strategy assures success or protects absolutely against loss, but given the overwhelmingly positive start to the year, now is a good time to realize positive gains and reallocate to an appropriate base allocation. In addition, and given the frequency with which corrections occur, investors are well served to control their emotions and refocus on what new opportunities may exist.

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Kevin Fusco is senior vice president of Fusco Financial Associates Inc. of Towson. He can be reached at 410-296-5400, extension 109, or Kevin.Fusco@LPL.com.

Published: Tue, Mar 27, 2012

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