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Perspective on Extreme Market Volatility

Posted by The HFM Team on August 18, 2011

The last few weeks of market volatility have certainly been historically significant.  The fluctuations from day to day have been as extreme as any our team has witnessed in collective memory.  While there has been some retracement from the recent market lows, we realize that these gains in themselves do not quell the worries you may feel about the market and your investments.

In periods of heightened market volatility we believe it is important to recall that short-term gyrations are not necessarily the indication of, or precursor to, long-term declines.  Looking back at history, the markets have demonstrated resilience and many of the worst short-term declines have been followed by significant rebounds. Since 1950, the U.S. stock market, as measured by the S&P 500, has declined more than 13% over a three-consecutive-calendar month period on 23 different occasions.  In 15 of these 23 instances (65% of the time), the stock market rebounded by more than 20% over the following year.  In 12 of the 23 selloffs, the subsequent rally was large enough to recover all of the market’s previous losses and then some.1

It is reasonable to feel some anxiety in times like these with the combination of market volatility, budget and taxation debates, and economic uncertainty.  However, we believe that knee-jerk reactions will more than likely compound any current losses and impair the ability to earn appropriate future gains.  To help put the current situation in context there are some salient points investors should consider.

The first, noted above, is that most historical selloffs have been followed by rallies.  The second is that the gains from these rallies are usually concentrated over a relatively small number of days.  Looking at the S&P 500 from July 1, 1981 through June 30, 2011, an investor who missed out on only the five best-performing days in the market would have ended up with a portfolio worth roughly 35% less than one who had been fully invested throughout the period.2

We believe that predicting the days with the greatest concentration of gains while avoiding those with losses is extraordinarily difficult at best.  In fact we have yet to witness any evidence that such predictions are possible with any repeatable significant accuracy.  Instead, we believe it is better to structure portfolios for the long run than to potentially miss those best days.  Our investment programs emphasize dividend paying companies and other securities which generate income because this approach has demonstrated the ability to lessen the ill effects of market down-turns over brief and extended periods.  This approach prepares client portfolios specifically for market events such as the ones currently unfolding while avoiding the pitfalls of market timing.  Our portfolio managers each have more than 25 years of industry experience which includes many periods of extreme volatility.  The entire team’s experience and expertise is collectively applied in the constant analysis, monitoring, evaluation, and management of our clients’ investment programs and we will continue to do so in this challenging market environment.

If you would like to discuss what this volatility means for your specific situation, we encourage you to call.

Thank you for your trust and confidence.

Sincerely,

The HFM team

1. Bloomberg and FMR Co.  2. FMR Co. and FactSet