Explore the implications of stock market volatility on your investments and how to navigate through it successfully.
In light of recent stock market trends, many are left questioning if they should worry about stock market volatility. While much of the early August volatility was caused by high-risk trading strategies, the jury is still out on the condition of the U.S. economy.
Here we explore the significant impacts and how investors can navigate market volatility without panic.
FAQs
Q1: What are the main causes of stock market volatility?
A1: Stock market volatility is primarily caused by economic indicators, investor sentiment, and external shocks.
Q2: Should I sell my investments during market dips?
A2: Selling during dips locks in losses; often it is better to ride out volatility with a solid strategy.
Q3: How can I protect my investments from variability?
A3: Diversification and long-term planning are key portfolio strategies.
Understanding The Recent Stock Market Volatility
On August 5, 2024, the S&P 500 Index dropped 3% from its previous close, the largest single-day loss in almost two years.
This continued a three-week slide that saw the benchmark index — generally considered representative of the U.S. stock market — decline by 8.5%.
The tech-heavy NASDAQ Composite Index dropped even further, losing 3.4% on August 5 and more than 13% over a four-week period.1
In the early morning, the CBOE Volatility Index — often called the fear gauge — reached the third-highest level in its history, eclipsed only by the 2008 global financial crisis and the 2020 pandemic crash.
By the end of the day, however, it had settled to a more normal level for a down day.2 And the market rebounded quickly.
Two weeks later, the S&P 500 was just 1% off its all-time high, while the NASDAQ was about 4% down from its peak and riding an eight-day winning streak.3
Avoid Panic During Stock Market Volatility
If you were paying close attention to the market on August 5, it would have been natural to be concerned.
But as the subsequent bounce back illustrates, it would have been unwise to panic and change your investment strategy in response to the temporary volatility.
Selling when the market declines is the surest way to lock in losses, and you may miss out when the market rebounds.
Strategies For Investors To Combat Stock Market Volatility
Most individual investors are best served by building a diversified portfolio appropriate for their goals, time frame, and risk tolerance, and letting the portfolio ride market swings and pursue growth over time.
Over the last 30 years — a period that included three recessions — the S&P 500 has returned an annual average of about 10.7%, assuming reinvestment of dividends.4
Of course, returns have varied widely from year to year, but pursuing long-term growth is at the heart of being an investor versus a speculator.
As Nobel laureate economist Paul Samuelson put it, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”5
Being a long-term investor does not mean you should totally ignore market movements or never change your investments.
What’s important is to distinguish between events that cause short-term market volatility and fundamental business and economic changes that may lead to longer-term market shifts.
As an example, it might be helpful to look at the recent volatility.
Economic Indicators Influencing Stock Market Volatility
The market slide was caused in part by concerns that the U.S. economy might be slowing and that the hoped for “soft landing” from the Fed’s inflation-fighting interest rate policy might be harder than expected, possibly even ending in a recession.
This concern was increased by a disappointing jobs report released on Friday, August 2. The S&P 500 dropped 1.8% that day, and the NASDAQ dropped 2.4%, sending it into correction territory (a decline of more than 10% from a previous high).6
High-Risk Trading Strategies and Stock Market Volatility
While these were genuine concerns about the U.S. economy, there was also a web of complex high-risk trading strategies coming unraveled and driving the volatility.
These strategies depend on borrowing or “leveraging” that magnifies the potential gain while also magnifying the potential loss
Bank Of Japan and the Yen Carry Trade
Hedge funds and other speculators had borrowed billions of Japanese yen at ultra-low interest rates in order to buy other investments.
While many central banks had raised interest rates to combat inflation, Japanese rates were still near zero due to years of economic stagnation. When the Bank of Japan raised its policy rate on July 31, the yen became more expensive, leaving speculators scurrying to disentangle their leveraged bets.
The August 5 market mayhem began in Japan, where the benchmark Nikkei 225 Index plunged by more than 12%. By August 6, bets against the yen had dropped more than 80% from their peak.7–8
Technology Stocks and Small Caps
Another heavily leveraged strategy involved buying large quantities of technology stocks, betting big on the future of artificial intelligence, often while betting against small cap stocks, which have suffered from the high interest rate environment.
Poor earnings reports by big tech companies, combined with the prospect of lower interest rates that would help smaller companies, blew up these bets and forced speculators to try to cut their losses.9
Stock Market Volatility and Future Economic Uncertainties
While much of the early August volatility was caused by high-risk trading strategies, the jury is still out on the U.S. economy.
Investors will closely watch upcoming economic data and events, including the August employment and inflation reports to be released on September 6 and 11, respectively, and the Fed meeting on September 17–18, where central bankers are widely expected to reduce interest rates.
The November election, regardless of outcome, is also likely to stir markets
However, as recent volatility illustrates, it’s generally wise to tune out the noise and stay the course of your own investment strategy.
Ultimately, understanding stock market fluctuations can empower investors to make informed decisions without succumbing to panic. By focusing on long-term strategies and maintaining a diversified portfolio, investors can better manage the risks associated with stock market fluctuations.
Contact your tax and financial advisors to determine the best moves for your situation.
1, 3, 6, 8) Yahoo Finance, S&P 500 Index for the period 9/1/22 to 8/19/24, NASDAQ Composite Index for the period 7/1/24 to 8/19/24, Nikkei 225 Index for the period 8/2/24 to 8/5/24
2) The Wall Street Journal, August 6, 2024
4) London Stock Exchange Group, S&P 500 Composite Total Return Index for the period 8/15/94 to 8/15/24
5) Investopedia, September 15, 2023
7, 9) The Wall Street Journal, August 12, 2024