Do Choppy Markets Keep You Up at Night?

Welcome to the "Informed Investor". Today's topic is going to be about the big ups and downs in the market, which we refer to as market volatility. I'm Mark Gochnour. I'll be joined today by Jake DeKinder and Wes Crill. I like that jacket Goch. I think I've been working on my game a little bit. I can tell. It almost looks like you're like sponsored by somebody. I didn't get the blue jacket memo. You guys should have called me. We should have. On one of these we're gonna match. We're just gonna like wear the exact same outfit. I hope so. Yep. I think one show we'll rotate jackets and see if anybody messes throughout- Maybe some different sides, we'll see. All right, market volatility. Again, the big moves in the market up and down. Let's just set it straight here, everybody loves the upside, the real worry comes to down markets, like what's gonna happen if we have a big drop in the market? Well, I mean I think you're right on that, right? I mean this is almost like the classic fear and greed, right? People love the upside, they get concerned on the downside, and the question really is, what are you gonna do about it as an investor? 'Cause the reality is, is markets go up and down and you gotta be prepared for it. Well, it's interesting to have this conversation now because if you look at most market based indicators for expected volatility, they're not particularly elevated. And yet if we look at where a lot of the flows are going, especially with the active equity ETFs, they are going into strategies that are targeting mitigation of downside risks. So, it means it's on people's minds and I think it's a worthy topic to discuss today. Well, let me set up the conversation. We always like to read a couple headlines here. So, I'm gonna start with a few. And this is gonna be back more when we did see a pretty big spike in volatility kind of early April there when a lot of conversations are going on with the tariffs. So, two, I wanna highlight. The first one, extreme volatility sends US stocks on a rollercoaster ride. And the second one, markets cannot go on like this. And then I wanna bring it back to more recent time you alluded to volatility, I'll say softened it a little bit since then. So, here's one, market volatility is set to make a big return. All right, there's so much to unpack in there. I like the one that I think you said from a couple of months ago, markets cannot go on like this. And that was a period where I think it was a little bit more volatile in the markets when that one came out and I would kind of flip that around and be like, "I'd actually be concerned if markets didn't go on like that." Yeah, what does it mean they can't go on? Exactly. They can't go on processing information? That's what defines the market. So, it's an interesting concept. Big news comes out and you don't see market swings, right? I mean people aren't adjusting their risk preferences, markets aren't processing information. Then, I would say, "Okay, now we've got some problems." Key point, it's always processing information, and it should be titled, you always want markets to behave like this. Yeah. Meaning bringing new information into prices of any stock- Completely. or any bond out there. But let's go back to that time period early April. Very high volatility. I'm gonna read a couple numbers here and almost just reflect on this for a moment and get your thoughts on it. So, this is back on April 3rd, around that Liberation daytime period. So, April 3rd, it was down 4.8% in the market and then the next day it was down 6% and then a couple trading days later it was up 9.5%. So, that's where a lot of these headlines were coming from about, you know, this reference chaos in the market. Those are big days for sure. You know, you mentioned those two days where it was down, I believe those were the worst two days for the US stock market since COVID. And then you get the one really big bounce back day, which was I believe the best since the global financial crisis back in 2008. So, it certainly is consistent with my memory of it where those were very volatile days when with a lot going on and when you have changing in the information set, you should expect that markets are gonna be going up and down. Well, you would think so. You also go back and look at trading volumes. On that Monday following those two big down days, I think we saw one of the largest days of trading volume that we had seen in a long time in the markets. And then two days later, on that, I think it was the Wednesday, where you said you get about a 9 1/2% pop in the markets. Same thing, massive trading volume. And that's the point that we hit at the beginning which is, you wanna see high trading volume. You wanna see... I'm not saying you wanna experience volatility as an investor 'cause I appreciate that when the markets are getting choppy, people get concerned, right? But from, I'll say an academic standpoint, wouldn't it be weird if that wasn't the way that it was working? It would be odd. And then you mentioned, you know, the one really big bounce back day, April 9th I believe it was. So, what was interesting around that time period was the lesson you learned in terms of sticking with your investments. Because if you look at the trailing one year return on the S&P 500 on April 8th, so before that bounce back, it was I believe minus three percentage points. You look at the trailing one year return on April 9th, and it was positive six percentage points. So, there is a lesson there by not reacting to the downside because you might miss the upside. Well, another point you always like to make is is that it's the largest sense. It's the biggest. I mean, that's the thing you also gotta appreciate, I think you just said that those two down days were the biggest since COVID and then the biggest update was the biggest since the financial crisis, right? And you're always reading the article, it's the biggest, it's different this time, it's the largest, and you gotta be prepared for that. Well, I like that idea, it's different this time. It's always part of that headline when you get into some tough time periods. And I go back to that Liberation Day on tariffs. Was it different? Absolutely. Absolutely. Others being proposals on tariff rates we hadn't seen in probably a hundred years or so. So, it was different. So, it can't become very emotional around that. But I always like to think through too. And it's idea of, have we lived through it before? And by that I mean the big ups and downs in the market. So, let me give you a couple numbers here. And this goes back to 1979, I think that's when Russell 3000 started and we have some market data around that. So, what we're looking at here are inter year declines in ups in the market. So, for example, on the declines, if the market at some point throughout the year was down 20%, that's what we're referring to here. So, since 1979, there's been 11 years where the market at some point in the year went down 20%. Now, of those 11 years, five years ended up being positive, six years ended up having a negative return that year. So, highlight that just to say, we've been through it before as an investor. And while it is difficult, usually it works out pretty well if you just sort of stick to your plan during those time periods. Now, the other side, and we have to highlight this just because you said most people are concerned about the downside, but if you look over that time period again, 30 years, the market at some point in the year, it went up 20%. And of those 30 years, 27 years were positive, only three were negative. So, what's your takeaway? I mean, jokingly, you know, we say this all the time, markets go up and down, they tend to go up a little bit more than they go down, right? And I think that's what you're showing right there. You do get downturns in the market, but when on the other side of it, a lot of times you have more upturns. And again, what's the market done over time? It's gone up and down, but over long periods, it's tended to go up. Yeah, and I mean, like you mentioned, the downturns are gonna be part of investing. By the way, that's why you get paid the equity premium to bear some of that risk. And then you look at previous downturns, anytime it's been down by 10%, well over the next year the average return for the US market was almost 12%. So, you look at those numbers and you think, "Okay, well you know, this is what you could potentially miss out on if you were to deviate from your investment plan." You gotta be able to stick it out. I mean, we talk all the time about... We discussed this idea of an investor badge of honor, right? And that's what I think you gotta go through. Like go back to earlier this year where you get the two big down days and the big update, right? And if you stuck to your plan and made it through, you should be like, "Yeah, like I earned my investor badge of honor." Go back to March of 2020 for people that made it through March of 2020. Go back to '08, '09 time period, right? When you make it through these periods as an investor you should be like, "Yeah, I should wear a little investor badge of honor." And say, "Yeah, I made it through that period. Yeah I made it through that period." And that's how you capture the long term returns. You should go to a cocktail party with all your little badges- I'ma put put it right here on this blue jacket, it's gonna look great man. They call it flare and office space. How much flare you got? More flare the better. As an investor, more flare the better. That's what we're talking about man. Well, Wes, let me ask you this, periods of high volatility or when you get in periods of low volatility, does that tell you something about expected returns into the future? Yeah, it's a good question. The volatility characteristics themselves are persistent. We do tend to see that high volatility months predict high volatility in the next month. But there really hasn't been a reliable correlation between the volatility and returns, that high volatility months are sometimes followed by high return months, sometimes by low return months. There's really just not much of a relation there. Yeah, those days we talked about earlier, those best days that we've seen since, usually those best days are in some of the most challenging times in the market when markets are down low. Yeah. Lemme ask you this then. So, as an investor, what are your options? Let's say you do get into a time period, you're really worried about where the market is, you're really worried about the market's just really dropping off, what can you do as an investor? One place to start is maybe don't have the realization or make the determination of what you wanna do in your asset allocation during these periods, right? You wanna be prepared going into this. That means setting expectations around what the RYE can be and then forming an asset allocation. It kind of balances the potential upside with your tolerance for the downside. And so having a balanced portfolio is one way that you can, you know, mitigate that. I think that's a great point, knowing what you're getting into ahead of time. I've been reading some great books recently a couple that jump out actually, "The Wager", that's a good one. Shipwreck off the coast of South America in the mid 1700s. "Endurance", that's... You read that one? Yeah, I read that one too. Yeah, that's a Shackleton. Yeah, expedition of the Antarctic. And then another one you recommended to me, which I think was "Undaunted Courage", and that one was awesome. The Meriwether Lewis. Fantastic book. Oh man, fantastic book. And the reason I bring that up is, is that you're talking about being prepared for what's coming up, right? You're talking about setting appropriate expectations. And if you think about that adventure, right? They didn't know exactly what they were getting into, but they had the right mindset, they had the right gear, they prepared the best that they could and they faced some insane challenges along the way. And when they did, what did they do? They jumped into action and they executed the plan. They didn't panic, they didn't freak out, right? And as an investor, panicking is really never a good investment approach. It's a good lesson in life, and it's a good lesson in investing but that's not how you wanna approach that. As you're talking I think about too, it's knowing yourself. Yeah. As well. I think about my father-in-law for example, probably as risk averse as you can get as an investor, he just couldn't handle these big swings in the stock market. So, for most of his investing career, most if not all of his money was in like CDs and really safe bonds, fixed income, because he just couldn't handle the swings. Meanwhile, as an investor, he probably left a lot of upside on the table. I think it was absolutely the right decision for him because he could sleep at night. That's a really good... I mean, it's an excellent point, right? It's impossible for us to say... We get that question all the time, be like, "Well. what's the right asset allocation?" Be like, "That's absolutely impossible to..." I mean, I think good financial professionals working with investors can have that conversation, but it's really tough to answer because you have to kind of look inside yourself and say, "What can I stomach?" This is why I don't play golf, I can't handle the ups and downs. You know, and I think that's a really good point that, you know, the appropriate asset allocation's one you can stick with. In case of your father, that was something that was safer. And some other investors might be able to handle the ups and downs of the stock market, might not even look at their statements very often. And so to them it just looks like the market is going up and up smoothly. But I think, you know, understanding what you can tolerate in terms of market volatility is an important thing for investors to learn about themselves. It's funny that point not look too often. Just look at this year, right? We already talked about what we went through, we talked about Liberation Day, we talked about high volatility. Through June 30th, I think the S&P is up about 6% for the year. It's amazing. It's amazing, right? And if you look at the long term of the S&P, it's about 10, 10 point a half percent... I think it's right at like 10.4% over the last 99 years. So, you know, it's almost like if you went to bed on January 1st and woke up on June 30th, it'd be like, "Yeah, I got roughly the average." It was a pretty choppy year, but as we know, there's no really normal year in the markets. You know, you wanna expect the unexpected. Well, you think back to even 2023, getting to be a stale anecdote at this point, but there was a lot of contradiction, there was a lot of turmoil that year, whether it was geopolitical stuff, you know, financial issues with the United States and yet the global stock market was up I think 22, 23% that year. So, you know, this is a really good example of when you look back and say, "Wow, you know, we ended up getting a good market outcome despite what I was reading about in the headlines." And what were you feeling during those periods, right? I mean, you go back to some of those choppy periods and in the moment it seems like the biggest deal. And it's funny, we ask investors all the time, like you go back and be like, "So, what was the big event of 2019?" They're like, "I don't know." 2000. Yeah. Yeah. You forget after. I don't know. Very quickly. So, in the moment you're feeling this emotion, but as you start to extend that time period, you get out a little bit, you almost forget, "Well, what the heck was going on?" And again, if you just stuck to your plan, you're like, "Eh, it was probably fine." Wes, you made a comment earlier when we were talking about some of the flows we're seeing in the industry now going into some of these, I'll say products out there that can minimize some of the downside. Expand on that a little bit in terms of what you're talking about. Yeah, I mean again, that's a reasonable conclusion to have if you were concerned about market volatility is, I wanna do something to mitigate the potential downside. Then you wanna be evaluating, "Well, what is the appropriate way to do this?" You know, we already know that you can do that effectively by combining fixed income with your equities. There are new breeds of solutions that are focused more on equities that will have the allure of lessening your downside risk, but it might cover with the expense of your upside participation. Yeah, there's always a cost to that. You know, we should- Not getting it for free. We should actually... We should make that one of the- That's a good topic. That's a real good topic. Things that are out there and sort of the associated costs. Yep, be fun to unpack. Minimizing that downside. Alright, so a couple things. Jake, you say this, and I think it's totally appropriate, always expect the unexpected. It's a good mindset as an investor. And in markets, markets go up a lot more often than they go down. Mm-hmm. What would you add to it? Expected returns are positive, right? You know, when we talk about stocks, expected returns are always positive. And so when you have these periods of market volatility, you don't wanna lose sight of that. I think you guys nailed it. Thanks for joining us today on "Informed Investor". As a reminder, enable notifications for future episodes and with that have fantastic rest of the day.