Tuesday, October 20, 2020

Measure Twice, Cut Once

ASK THE CFP® PRACTITIONER


 

 

“A well-informed mind is the best security against the contagion of folly and of vice.”

~ Ann Radcliffe, The Mysteries of Udolpho, 1764 Question: Should I be worried by recent market activity? Answer: It’s normal to be worried or upset when markets pull back. Market volatility can certainly trigger emotional responses. After the sharp gains of 2017 and the noteworthy increases since the lows of 2009, we’re bound to see some profit taking and a downdraft.

One reason for increased volatility is that the stabilizing influences provided by the Federal Reserve System, such as quantitative easing, operation twist, and an extended period of low interest rates, are all probably coming to an end. The Fed is essentially passing economic control to the private sector as the economy strengthens. What’s Next?

It’s somewhat counterintuitive that a stronger economy could cause the downdraft, but markets dislike uncertainty and there’s a bit of that on the horizon. With new Fed Chairman Jay Powell, we’re not sure how fast interest rates will rise, there’s also trepidation over geopolitical risk, and domestic politics. Now that tax reform is a done deal there’s not an identifiable upside catalyst to send us higher. It’s a classic case of “buy the rumor, sell the news.” It’s natural for the market to pause, but don’t forget the facts; the Fed is transitioning because we do have a strong economy, a robust labor market, favorable tax reform and a constructive regulatory environment, all of which support corporate earnings, wage increases and real economic growth. Logic vs. Emotion

Investors face an uneasy tug-of-war between news and noise. Staying focused during turbulent times becomes more difficult. Burton Malkiel, author of “A Random Walk Down Wall Street” warns us to “Never buy anything from someone who is out of breath.” Avoid drawing hasty conclusions.

Capital market assumptions are generally based on strategic and tactical expectations. Tactical strategies align with shorter six to18-month intervals while strategic planning is usually three to five years or longer. Using a blend of both tactical and strategic approaches, while being mindful of traditional and non-traditional investment opportunities, may sound like a tall order, and it is. One methodology is to consider the best and worst case scenarios while assessing probabilities of potential outcomes. Unless you have an overactive inner geek, this is a process you probably don’t want to attempt on your own. If I Were a Carpenter

Carpentry requires precision and craftsmanship making the profession an art and a science. Financial planning is much the same way. By evaluating economic indicators and combining this with personal behavioral tendencies we can craft a plan. By studying two indicators in particular, we hope to maintain perspective and distinguish a “head fake” from a more serious market trajectory changes. The two measures used are the VIX or volatility index, and the TED Spread. The VIX, or fear gauge, estimates future volatility while the TED Spread reflects banks willingness to lend funds to one another. The TED Spread represents the change between the interest rates on interbank loans and short-term U.S. government debt or Treasury Bills. TED is an acronym for T (treasury) and ED (Eurodollar rates). The calculation is based on three-month bond rates.

Traditionally these two indicators are unrelated. When they both pick up speed it may mean that further investigation is warranted. We try to look at less likely measurements and to not always follow the herd. If you’d rather not examine these concepts yourself, it’s possible that you see the potential value of having a CERTIFIED FINANCIAL PLANNING™ practitioner on your team.

Occasionally a Black Swan event (surprising outlier) will occur, injecting fear and volatility into markets. When this extraordinary phenomenon takes place we often see shorter periods of volatility followed by a rebound, and then longer periods of calm. Rather than getting scared out of markets all together during such times, you may want to explore anchoring your financial plan to a disciplined strategy and working with a coach to help regulate your plan. Having sufficient cash on hand during these times might alleviate or mitigate emotionally based decisions.

Fear may cause irrational or herd mentality behavior based only on emotions. This is common during times of both anxiety and euphoria, possibly causing investors to abandon their planning process. If you’ve measured twice (or thrice) there’s no need to make irrational moves or cuts. Fortunately there isn’t just one correct approach to investing, just as there are no guaranteed outcomes. Stay focused and plan accordingly.

All investments are subject to risk. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. There is no assurance that any investment strategy will be successful. Asset allocation does not guarantee a profit nor protect against loss. VIX is the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market’s expectations of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. It is a widely used measure of market risk. The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index.

“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.” This article is provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. Call or email Darcie at 239-389-1041 or darcie.guerin@raymondjames.com with questions or suggestions for future columns. Visit her website: www.raymondjames.com/Darcie.

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