With markets becoming increasingly volatile this year, investors have started to question their investment decisions. The year 2018 has been a surprise to investors as there was an initial selloff period and then a strong rebound.
The question is, will an increased market volatility serve to be a problem for investors?
Even though volatility might not be favorable to investors as the risks associated with an investment go up, volatility fluctuations have been based on the current U.S. business cycle. The U.S. economy is currently in the later stages of a long period of expansion that followed the financial crisis of 2008. Until the economy started to get on a firm footing, the U.S. witnessed lower interest rates, an improving global economy, a Federal Reserve Bank that showed reluctance in pulling back on unconventional monetary policies and events like quantitative easing.
More recently, we have seen a pickup in global economic growth, which has started to raise concerns about inflation and what it could mean for the markets going forward. Theoretically, small amounts of inflation are healthy for the markets. However, a sudden spark in inflationary risk could prompt the Federal Reserve Bank to halt expansion and put a stop on economic growth by increasing the interest rates. This will in turn affect the global markets and corporate profitability for companies around the world. The small increase in volatility compliments the increase in uncertainty and this has started to come up during portfolio decision-making.
Taking into consideration the past market cycle short and medium terms, we can predict that the market will head lower because growth will eventually stall. Recession is a feature of the market and is also completely common throughout the world. When this downturn comes up, the markets will decline, and losses might be incurred. With the correct hedging strategies, it is likely that investors will be able to successfully jump from this potential hurdle.
Some worried investors might ask, should we sell? The answer to this question is dependent on how risk-adversity. Nobody knows when the next recession might occur because there is no definite answer. Predicting an event like the recession is complex and at times inaccurate. Investors who take an aggressive approach to their portfolio will play with the risk-return strategy embedded in their respective portfolios, but the ones who might be risk-averse could lose major returns if the recession never hits. Instead, hedging your portfolio through diversification might seem like an optimal approach.
Another perspective to think about might be your personal goals. If investors have achieved their monetary goals, it might make sense to take a less riskier approach. Sometimes hedging your portfolio and riding out the market jitters is a better idea than to liquidate your investments because of the small subtleties of how the market is designed with respect to the economy.