Feb. 2018 – February Shivers

In this issue we focus on the steep downturn in the stock market during the first two weeks of the month. The market had just completed a long stretch of remarkably high returns with low volatility when suddenly investors had the rug pulled out from under them.

In the first article we explain how the magnitude of the decline was exacerbated by products that bet heavily on continued market tranquility. A market dip quickly turned into a rout, with disastrous consequences for investors who placed bets on these “short volatility” vehicles. Thankfully, a well-diversified portfolio once again shielded investors from sharing this fate. We recount this episode to remind our readers that, while financial innovation will spawn new derivative products, such instruments should be approached with caution. Many are extremely useful tools for controlling risk in capital markets. But they also include speculative vehicles that are of little value to individual investors, and have no place within a portfolio designed for growth over one’s lifetime.

The second article presents external research that considers the likely consequences of trying to escape volatility by timing the market. The analysis makes clear that this strategy, as attractive as it sounds, is in fact quite risky. It turns out that being out of the market on just a handful of the best days in the market can severely reduce the likelihood of meeting your financial goals.

In the third article we summarize our own findings in which we evaluate empirically the popular idea that sharp short-term stock market declines create “buying opportunities.” Despite the intuitive appeal of this notion, there is little evidence to support it. We present historical outcomes following downturns and assess the relationship with subsequent returns.

Also in This Issue:

The “Short Vol” Trade and the Stock Market Decline
Recent Market Volatility
Do Market Declines Present a Buying Opportunity?
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles