Vanguard: How to Navigate Through Market Volatility

Global markets have turned volatile in recent weeks. Earlier this month when US markets crashed for a few days market experts were out in full force saying rising interest rate, valuations, etc. were the reasons for the sudden change in the direction of the market. Some simply said that markets were due for a correction after a long bull run. Amid all these noises and distractions many investors may be worried on what they should do in times like these.

According to an article at Vanguard UK, downturns in the market are not rare and a typical investor will experience such events many during the long-term. From the article:

It’s important to remember that corrections and bear markets are not unusual. Research by Vanguard’s Investment Strategy Group shows that since 1980, globally significant market events such as corrections or bear markets have happened about every two years. The typical investor will have to endure many such events over his or her lifetime.

Market downturns aren’t rare

Market downturns aren't rare

Source: Vanguard analysis based on the MSCI World Index from 1 January 1980 through 31 December 1987, and the MSCI AC World Index thereafter. Both indices are denominated in US dollars. Our count of corrections excludes those that turned into bear markets. We count corrections that occurred after a bear market has recovered from its trough even if stock prices haven’t yet reached their previous peak.

It’s also important to put volatility into historical context. Market uncertainty can cause investors to diverge from their asset allocation plans as they try to insulate themselves against turmoil. But trying to time these events can lead to costly mistakes. In many cases, timing the market for re-entry simply results in selling low and buying high.

Many downturns barely register when taking a long-term perspective

Many downturns barely register when taking a long-term perspective

Note: Intraday volatility is calculated as daily range of trading prices [(high – low) / opening price] for the S&P 500 Index. Sources: Vanguard calculations, using data from Yahoo! Finance.

Indeed, the markets’ best and worst trading days have often happened close together. In fact, the worst trading days actually happened in years with positive performance.

The markets’ worst days and best days are often close together

The markets' worst days and best days are often close together

 

Source: How to navigate through market volatility, Vanguard UK, Feb 7, 2018

The article notes some strategies for investors to navigate uncertain markets. Readers may want to read the full article at Vanguard site.

Emerging Market Shocks and Rebounds

Emerging markets also tend to bounce back sharply after major market declines. This phenomenon is similar to developed markets where dramatic falls are followed by strong recoveries in the following months and years.

The table below shows some large emerging market crashes and the ensuing rebounds:

Click to enlarge

Source: Emerging-Market Resilience, Franklin Templeton

Emerging markets are not prone to declines not only due to local issues but also due to global events. For example, rising US interest rates can adversely affect emerging market stocks.

Though EM stocks got crushed during the Global Financial Crisis of 2008-09 they soared back like a rocket to gain over 135% in two years.

Related ETFs:

  • iShares MSCI Emerging Markets ETF (EEM)
  • Vanguard MSCI Emerging Markets ETF (VWO)

Disclosure: No Positions

On The Importance of China in Emerging Markets

China has the second largest economy in the world with a GDP of over $11.4 Trillion. The country is also one of the largest trading partners in the world. The US is China’s largest trading partner and China exports more goods to the US than it imports.

Below are some fascinating facts about China from a recent by Justin Leverenz at Oppenheimer Funds:

  • China’s GDP is larger than the combined GDPs of Africa, Latin America, India and Russia.
  • The country’s equity market capitalization at about $12 Trillion is the second largest in the world after the US.
  • In the MSCI Emerging Markets Index, China accounts for 29.7% of the index. When MSCI includes A-Shares in August this year the portion will rise to over 37%.

A short excerpt from the piece:

China’s role as a trading partner puts it in a unique position. Indeed, it is the largest trading nation in the world, at $3.96 trillion in net trade activity in 2015. That year, 101 countries and regions had more trade with China than the United States, while 43 (mostly developed countries) had less. In 2014, China accounted for 48% of Taiwan’s exports, 34% of the Philippines’, 33% of South Korea’s, 49% of South Africa’s, 28% of Chile’s, and 24% of Malaysia’s.

 

Click to enlarge

 

Source: On the Ground in China: Observations from the Middle Kingdom by Justin Leverenz , Oppenheimer Funds

In addition, China is also a voracious consumer of many of the major commodities. For example, according to the author China consumes some 13% of Russia’s oil, 28% of Brazil’s iron ore, 33% of Indonesia’s thermal coal, and 40% of Chile/Peru’s copper. Chinese traders are also major importers of Cobalt from Congo which is used in batteries for electric vehicles according to an article in WSJ this week.

On The Correlation Between The Russian Equity Market And Oil Prices

The Russian equity market is highly correlated to the price of crude oil. Since Russia is one of the largest oil producers and exporters in the world, Russian stocks perform well when oil prices are high. Conversely declining oil prices leads to lower equity prices.

The chart below shows the close relationship between Russian stock market and oil prices:

Click to enlarge

Source: Investing in Russia’s Resurgence, by Justin Leverenz , Oppenheimer Funds

From the above article:

Russia could very possibly be the best performing market in the world this year. This is not an attempt at hyperbole, but rather a recognition that a convergence of variables, partnered with extremely attractive valuations, have set the stage for the market to shine.

But it has been a long and difficult road to get to this stage. The Russian market is closely linked to the oil price (see chart), so the collapse of oil from $140+ to below $40 in 2008 marked the start of almost a decade of disappointment. In that period, Russia’s influence in the emerging market (EM) world waned. At the end of 2007, its index weighting was 10.1%, fourth highest after China, South Korea and Brazil, with a market capitalization of $1.2 trillion. Today its weighting is just 3.3%. And its capitalization is less than half of what it was 10 years ago! Since mid-2017, oil has enjoyed a renaissance, currently flirting with $70 levels, with increasing confidence that $60+ is sustainable. The ruble – which is intricately linked to crude oil prices – has stabilized, having fallen 40% since oil stumbled violently in October 2014.

The entire above-linked article is worth a read.

Corrections Are Normal in Equity Markets: Australian Example

Pullbacks are normal in equity markets. Over the long-term stocks tend to always climb a wall of worry and yield positive returns. So short-term corrections should not surprise long-term investors. Generally stocks go up when considered over many years. To put it another way, though corrections occur every now and then, stocks yield positive returns over the long-term measured in years and decades. The following example of the performance of Australian stocks since the 1900:

Click to enlarge

Source:The pullback in shares – seven reasons not to be too concerned by Shane Oliver, AMP Capital, Feb 9, 2018

From the recent GFC to tech bust of the late 1990s Aussie stocks have recovered ground each time and have continued to go higher.