Bear market: unless riding rollercoasters is your thing better sit this one out

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Powered by article titled “Bear market: unless riding rollercoasters is your thing better sit this one out” was written by Suzanne McGee, for on Sunday 24th January 2016 12.00 UTC

As if it weren’t bad enough being mauled by a bear market, we have to get mauled on a rollercoaster as well.

The UK entered a “bear market” last week – one where the indexes have dropped 20% from their highs. Here in the US we are suffering wild swings but we’re not technically bear yet. Taken day by day, the percentage-point movements sound anodyne enough – 1% here, 2% there. Until you realize that they translate into the kind of movements in the major stock market indexes and individual stocks that we simply haven’t witnessed in years.

As of late last week, 475 companies in the Standard & Poor’s 500 index had posted losses for the year to date, while nearly half had lost at least 10% of their value, with metals and energy companies leading the way lower. Only two companies had managed to post a 10% gain: Macy’s and Southwestern Energy.

And for context, Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, reminds us that a 1% decline in the S&P 500 means that investors lost $163bn; a 1% drop in the value in the Dow Jones Industrial Average translates to a loss of $46.5bn.

The reason for this carnage? Well, it’s not terribly tricky to discern, especially when you consider the timing of the New Year’s market meltdown, which kicked off only a few weeks after Federal Reserve policymakers finally bit the bullet and began raising interest rates.

Unhappily, the Fed’s public statement that it wasn’t going to give easy financing to folks who wanted to borrow money to invest and speculate (a key factor in keeping volatility low) coincided with more bad news out of China. It seems that that country’s central bank isn’t in a position to manage volatility in its own financial markets any longer, and the resultant uncertainty has spilled over into global markets. Basically, we can’t rely on any of the central banks to wade in and calm the troubled waters. Nor do the large banks – institutions like JP Morgan Chase, Bank of America or Citigroup – have the capital or risk appetite to step in and serve as buffers amid the chaos.

In all likelihood, therefore, we’re in for a much longer period of volatility, coupled with big selloffs, than any of us are going to enjoy. As big hedge funds get caught in money-losing positions and try to shed them; as mutual funds try to minimize losses; as individual investors panic and flee to the sidelines in response to all the drama, losses will mount, and so, too, will risk aversion.

The problem for many investors is that there’s really no way for most of us to respond actively to this state of affairs, beyond buckling ourselves in tight, gluing our eyes shut and praying for the ride to end as rapidly as possible.

Almost the only winners in this nightmare scenario have been those hundreds or thousands of professional traders who have found a way to profit from the nearly 50% increase in the value of the CBOE Volatility Index, or VIX, since the beginning of the year. As volatility has climbed, more have plunged into the world of specialized volatility funds, or sought to trade options or structured products tied directly to the VIX itself. They may be the only people celebrating right about now, unless any hedge funds decided to place big bets against the entire market late last fall.

So, should you do likewise?

It’s not impossible. In recent years, the number of exchange-traded products available to give you exposure to the “fear index” as a proxy for volatility have increased, and yes, they can do well in short spurts.

The problem is that the funds that come closest to mimicking the performance of the VIX are pretty exotic structures. These investments aren’t for everyone, of course. The leverage means that if the amount of volatility dips, then the products of this kind of vehicle will fall far more dramatically than a more plain vanilla product.

Another option to consider – if you want to take some risk – is betting that markets will calm down at some point. In that case, you could take a look at some of the exchange-traded products designed to allow you to bet on inverse volatility, meaning that you’ll do well if this period of turmoil proves short-lived. If you do, you might find yourself with a lot of company: pro traders suggest that if it weren’t for some folks betting that this is just a nasty, brutish (but short) beginning to the year, volatility might be even higher. All of the speculators loading up their portfolios with these positions might actually have a “dampening effect” on volatility levels, they suggest.

Don’t like my use of the word “speculator”? Too bad.

The harsh truth is that anything you do in response to this unpleasant turmoil is going to amount to speculation. Certainly, betting on volatility trends is the polar opposite to long-term investing, which, in turn, is what you should be doing with your retirement savings.

Another speculative bet that you could make is to take shelter in the gold market. Gold bugs argue that this is the time for the precious metal to shine once more, after falling 12% in 2015 to wrap up the year at about $1,060 an ounce, the lowest price it has recorded since the financial crisis in 2008 and bringing its total losses to more than 40%.

Gold hasn’t generated nearly as spectacular results as has volatility, but at least it has outpaced other commodities and held its own, actually gaining ground as stocks have plunged. Despite the fact that gold is priced in US dollars, and a strong US dollar typically is bad news for the metal, gold has actually risen about 3% so far this year.

Like volatility, this is an investment you can access best via exchange-traded products, even if (like volatility), it can often be hard to find the perfect match between the product and the investible security. A favorite product is the SPDR Gold Shares, which is finally recording inflows of new assets so far in 2016 after two straight years of outflows.

Yes, the market – and in particular the volatility index – is sending clear signals that the selloff is more than likely to continue for some time, with fear trumping greed. But why let either of these emotions rule what should be long-term investment decisions?

Instead of hopping aboard the terror ride, I’d suggest doing something that requires still more courage: quitting the amusement park altogether.

If you don’t need those retirement assets for a decade or more, turn off CNBC and go see a movie. Volatility can and will terrify you – stare into the abyss, and it will stare right back at you, and tempt you to do stuff that you may not really understand (like trade volatility) or that might not be right for your portfolio in the long run (like overloading it with gold).

At its worst, watching every gut-wrenching movement in such a volatile market could end up costing you your sanity. No investment returns can compensate for that. © Guardian News & Media Limited 2010

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