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July Commentary: Brought to You by the Word Volatility

The first half of 2016 has certainly not had any shortage of headlines. From terrorist attacks in Dallas, Orlando, Paris, Istanbul and now Nice, to continued tensions between police departments and communities of color across the country, to Brexit and the most contentious Presidential primary campaign in at least 40 years, it is hard to feel something other than exhaustion when it comes to the world stage.


It is therefore understandable that investment market performance has largely gone unnoticed. Despite being under the radar, there has been plenty to talk about. The year started with a mini-crash, which saw markets drop around 10% during the first six weeks of the year. That was followed by a rally of equal proportion. And after a period of relative calm, the Brexit vote created an instant 3-4% sell off in US markets, only topped by the 7-10% sell off in markets across Europe and Asia. And now? Well, this week the S&P500 closed at an all-time high on July 11th, while the Dow Jones followed suit on July 14th. In fact, as I am writing this article, the S&P500 and Dow Jones are each up over 3% in the last two weeks alone.


So what does any of this mean? I think it is safe to say that this year's stock market performance is, and will continue to be, brought to you by the word VOLATILITY. In financial terms, volatility is defined as the statistical measure of the range of returns for a given security of market index. It refers to the uncertainty of the value of a particular investment and therefore represents the risk of an investment. Higher volatility means higher risk.


What makes the current environment different is that the whole world is more volatile. And the dirty little secret is that there are plenty of people who like it that way. While traditional investors have always believed that a deeper market was the key to investment success, we have entered a period where investors are thriving on volatility and in fact wishing for it. Why, you ask? It's simple, volatility creates the opportunity for gain among active traders.


So here is how it works. When people have an emotional reaction to a news headline, they freak out and sell their investments. In so doing, they create a discount on otherwise strong investments. And like a lion hunting its prey, savvy investors lie in wait, and when the price drops...they pounce.


Take one of the international news stories that I mentioned in the opening paragraph. Brexit, for example. And a well known stock that people like...Alphabet, Inc., the stock formerly known as Google (GOOGL). In the two trading days following the Brexit "leave" vote, Google went down nearly 6%, or more than $39 per share. Did the Brexit vote mean that all of a sudden Google was truly valued at 6% lower than it was just hours before? Of course not. Especially when you consider how many British citizens used Google the next day to figure out what they actually voted for. This was pure volatility; pure fear; pure emotion.


As for the aforementioned "sharks in the water"...they fared pretty well. Investors who purchased Google at the 6% discount served up by fear have seen the stock rise 8.5% in the three weeks since. Oh, and let's not forget the people who already owned Google before Brexit and were smart, and didn't sell. They have seen their stock values increase by 3%. The ONLY losers here were the people who gave into fear.


So what is the moral of the story? If you ask me, it is that volatility is here to stay, at least for the foreseeable future. For as long as there are stocks to invest in, people will be looking for ways to maximize their return. And when you consider the fact that we are in the 8th year of a very strong bull market, in which US markets are the standard bearer, coupled with record low interest rates and European and Asian stocks wholly unreliable, the volatility play is as good as any for those seeking additional return.


That said, just as the name implies, volatility is highly volatile. It is risky. Return-seekers understand the risk, and use strategies that they hope are right more than they are wrong. It is not an overarching strategy for any well-diversified investment plan. Well-diversified plans rely on their diversification to achieve long-term results. They, by nature, reduce volatility because of the range of investments. Sure, when the market is as a whole more volatile, well diversified plans are more volatile too. But there is no data that shows anything other than diversification as a viable method for achieving the best results in the longest term.  


Always remember that regardless of everything going on in the world, investing has a cycle. That means there will be another downturn, and there will be another recession (not tomorrow, don't worry). And when that happens, the volatility play will crash and burn. That is the risk. So while in some portfolios it makes sense to have a small amount of exposure to volatility, the middle of the fray is still the safest place to be. 




Market Data furnished by Yahoo, Inc. Finance

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