Doctors Living With Higher Stock Market Volatility

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Change is afoot in the market, the rally of which lulled many into complacency


By David Gratke

DOW DJI 34,899.34 at close
-905.04 (‎-2.53%)

Volatility, on vacation for most of the past few years, is back this fall for physician investors and us all. It hit a new 52-week high in mid-October, double the level of August. That means change is afoot in the market, whose rally lulled many into complacency. So. this is a good time to see where your portfolio stands in risk terms.

The last time volatility really spiked, as measured by the Standard & Poor’s 500 volatility index, or VIX, was the fall of 2011 when the market last corrected by 20%. Then, the VIX level was twice as high as now. Volatility is market price fluctuation, and it signals greater risk.

Financial Risk

financial risk

The root cause of higher volatility is that the world’s major central banks, including our Federal Reserve, have flooded markets with liquidity – printing money, if you will. In other words, in an effort to jump-start local economies, they have kept rates so low that stocks are artificially higher, and thus ripe for a price-churning correction. The insidious side-effect of this money printing has been to greatly reduce, if not extinguish, historical, and normal, market price fluctuations.

As David Kotok, chairman and chief investment officer of Cumberland Advisors, puts it: “An era is ending: for over half a decade, nearly worldwide, zero interest rates suppressed volatilities. That is over.” The initial indication of this, Kotok says, was when then Fed-Chairman Ben Bernanke indicated that his bond-buying stimulus program was coming to an end. Well, now it’s over and the market fears interest rates are on the way up.

Investor Sentiment

Transferrable  Emotions

Stock market volatility can be measured and is used to gauge investor thinking, or what we call investor sentiment.

The VIX gauges investor sentiment. When volatility is low, the implication is that investors are complacent. Said differently, they are not paying attention to the underlying risks in the marketplace. Also during times of low volatility, markets are often fully valued, or even overvalued due to investor contentment.

When the VIX is high, as it was during the 2008-09 financial crisis, investors exhibited great amounts of fear. They sell out of their investments, and markets are typically undervalued.

Volatility was low prior to 2008, hovering around its historical average of 20. The index then zoomed to 90 during the 2008-09 stock market slide. In recent months, however, most notably June and July, we witnessed a historic low in this index, hovering near 10. Sure enough, there were high levels of margin balances and bullish investor sentiments, along with above-average stock valuations, as seen by lofty price/earnings ratios.

Now, the VIX is slightly below average, at about 15.

Since August, volatility rose from its sleepy historic mid-summer lows for many reasons: Middle East tensions, the Ebola outbreak, low gross domestic product growth, central bank stimulus slowing down, corporate stock buybacks, high P/E ratios, just to highlight a few.


A New Normal?

Assuming this higher volatility is the new normal, what can you do about it? One alternative is to do nothing and ride this out. Another is to trade options, betting on which way the market will cut. But this is very risky and best done by professionals. Kotok says a volatility surge is a good time to examine your portfolio’s risk profile: His firm’s largest positions are in defensive stocks, like utilities and telecoms – ones that don’t tend to rocket around when the market gyrates.

During a recent volatility boost to the current level, in 2013, a Wall Street Journal story offered some market pros’ tips. Examples: putting money in a balanced fund, where stocks and bonds are in roughly equal proportion. Another warned that whenever stock holdings were over 70% of a portfolio, or under 30%, you are most vulnerable.

Regardless, Kotok cautions that “more and exciting volatilities lie ahead.”

Follow AdviceIQ on Twitter at @adviceiq.

About the Author

David Gratke is chief executive officer of Gratke Wealth LLC in Beaverton, Ore.


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7 Responses

  1. Volatility and Risk

    David – One important thing to understand about Modern Portfolio Theory (MPT) is that Markowitz’s calculations treat volatility and risk as the same thing.

    In layman’s terms, Markowitz uses risk as a measurement of the likelihood that an investment will go up and down in value – and how often and by how much. The theory assumes that investors prefer to minimize risk. The theory assumes that given the choice of two portfolios with equal returns, investors will choose the one with the least risk.

    Thus, if physician investors take on additional risk, they will expect to be compensated with additional return.

    Dr. David Edward Marcinko MBA CMP™


  2. 3 Wacky Market Predictions For 2015

    Everyone loves lists, year-end lists even more so, and year-end lists containing forecasts for the next year sit at the top of the hierarchy. What would the week between Christmas and New Year’s Eve be without a stream of predictions for the following year?

    However, there is a right and a wrong way to make such a list. With some help from another one of my favorite authors, Josh Brown, here are my thoughts on these lists.

    Lon Jefferies MBA CFP®


  3. Market Volatility

    Extreme volatility is not a good sign. The bears and the bulls are in a bitter battle. The inter day price movements have become even more erratic lately with big point swings in the U.S. markets during the trading day.

    An up swing during the morning turns into a big downward reversal in the afternoon. This is a warning sign along with a massive rush to bonds. The U.S. ten-year bond is my fear gauge, a lower yield equals more fear. The yield went from 1.92% on Monday to 1.82% on Friday. That doesn’t seem like much of a drop but takes a lot of buying to move the yield.



  4. Pension Partners, LLC

    In my presentations done around the country for Chartered Financial Analyst (CFA) Chapters and Market Technician Association (MTA) Chapters, I make it a point to always say that “your ability to stick to a strategy matters more than the strategy itself.”

    What prevents people from sticking to an investment strategy, particularly in stocks, is volatility, drawdowns, and emotion. This is precisely why the problem with buy and hold over time is that nobody holds – emotions get the better of most.

    Crucial to everything we do in terms of being aggressively defensive in our alternative and equity mutual funds and separate accounts is that volatility on average is higher than it has been in the small-sample outlier of low volatility of the past year and a half. “Risk-on/off” behavior is finally re-asserting itself, which is a positive development for investment strategies which tend to manage risk pre, not post.

    Those investment strategies build on our award winning papers which document proven leading indicators of stock market volatility. I wrote about the change in dynamics which are crucial to our buy and rotate strategies in a recent Marketwatch writing:

    I encourage you to view my CFA Virginia Chapter presentation, available at

    Universally, the feedback has been that the content is thought provoking and helps to manage portfolio risk when it comes to wealth generation.

    Michael A. Gayed CFA
    [Co-Portfolio Manager of the Inflation and Beta Rotation Mutual Funds and Separate Accounts]
    Pension Partners, LLC


  5. How Recent Events Hinder Your Investment Return

    Investors should be conscious of the recency bias when developing their portfolio. The recency bias is the habit to assume recent trends in market activity will continue well into the future.

    For example, an investor might have the tendency to overweight large cap stocks in 2015 just because large cap stocks were the big winner in 2014, significantly outperforming small cap and international equities. This is dangerous because purchasing the asset category that has recently done well is frequently the equivalent of buying something when it is overvalued rather than positioning yourself to benefit from the market’s future movements.

    In another example, Tony Robbins recently published a new book titled MONEY Master the Game: 7 Simple Steps to Financial Freedom which falls prey to an increasingly popular version of the recency bias. Mr. Robbins worked with famous hedge fund manager Ray Dalio to create the so-called “All Weather” investment strategy. The asset allocation for the strategy is:

    30% Stocks
    40% Long-term Bonds
    15% Intermediate-Term Bonds
    5% Gold
    5% Commodities

    As Mr. Robins points out, the All Weather portfolio has performed quite well during the last 30 years. From 1984 through 2013, this portfolio averaged an annual return of 9.7%, achieved a positive return in 86% of calendar years, and never suffered a loss worse than -3.9% during a calendar year. Not bad!

    However, these backdated results create a significant error due to the recency bias. Unfortunately, these investment results reflect only the past 30 years, which happens to represent the strongest bond bull market in history. Assuming bonds will have an equally strong 30-year period going forward is questionable at best and destructive at worst. In fact, as investment analyst Ben Carlson showed, the same All Weather portfolio only returned 5.8% annually during the much longer time period of 1928 to 1983.

    Of course, my point is not that Tony Robbins’ book isn’t worthwhile, or that the All Weather portfolio is a poor investment. In fact, all of Mr. Robbins’ seven steps are sound financial practices, such as learning to invest in your future, keeping investment fees low, setting realistic rate of return goals, diversifying, and creating a retirement plan. Additionally, the All Weather portfolio may actually be an appropriate investment for investors who don’t need much return to achieve their retirement goals and are most interested in minimizing risk.

    My point, however, is that we should not let the recency bias skew our expectations for our investment portfolios going forward. It could be catastrophic if an investor assumed they would achieve a 9.7% annual return during retirement utilizing the All Weather portfolio only to have the historic rally in bonds fade out, making that rate of return unachievable. Similarly, it would be equally damaging to assume a loss of more than -3.9% isn’t possible, since examining results before 1983 tells us that this portfolio has lost as much as -17.5% in a calendar year.

    The recency bias can cause us to make unproductive modifications to our portfolios based on recent market movements. Further, over-weighting recent investment results and trends can lead to unrealistic expectations for our portfolios’ risk and return levels. These behaviors can be destructive to an investment strategy. Always be aware of our tendency to overweight recent market trends and resist the temptation to let them negatively impact your long-term investment strategy.

    Lon Jefferies MBA CFP®


  6. Why the Stock Market Is So Turbulent

    This turmoil started in China, but it now includes key factors like oil prices, emerging markets and the Federal Reserve.

    Any thoughts?



  7. Volatility and Rule 48

    The New York Stock Exchange invoked the little-used Rule 48 to pre-empt panic trading at the stock market open for the third day in a row on Wednesday. In a historic move, the exchange used the rule before Monday’s open following a dramatic drop in pre-market open futures, including the Dow Jones Industrial Average futures falling more than 700 points.

    The goal of Rule 48 is to ensure orderly trading amid financial market turbulence. It’s only used in the event that extremely high market volatility is likely to have a floor-wide impact on the ability of designated market makers (DMMs) to disseminate price indications before the bell.



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