Stock markets have had some head spinning moves over the last six months. The Dow Jones Industrial Average, down over 500 points at during trading on Friday, which officially entered into correction territory, defined as a loss of 10% from the high. For small-cap and transportation stocks, it’s been even worse, as they’ve entered a bear market, a loss of 20% from the high.
It’s not only stocks that have been volatile. Bonds and commodities also left investors reeling. Spreads on high-yield “junk” bonds have blown out as investors clamor for safer alternatives such as U.S. Treasuries. The collapse in the price of oil has been well-documented, yet it continues its struggle dipping down to almost $29 per barrel, a level last seen in 2003. Copper futures have gotten hit right along with other commodities including natural gas, coffee and silver. Copper has lost 58% down to its current price of $1.94, a level last seen in 2009. This is important because many seasoned professionals see copper as a more consistent predictor of global growth because of its industrial demand in construction.
To understand how bad this sector has become, consider Freeport McMoran, the Arizona-based copper and gold mining company. Its stock price has dropped over 90% since July of 2014.1 CNBC personality and Wall Street veteran Jim Cramer tweeted out that buying a ticket for last week’s record Powerball drawing might be “more investable” than [buying stock in] Freeport.2 Of course, this is a bit hyperbolic but it speaks to the level of negative sentiment around commodity names. A slowdown in China construction certainly isn’t helping Freeport’s situation either.
But a decline in commodities isn’t all bad-lower heating bills, cheaper airline tickets and gasoline down to a national average of $1.90.3 If you live in the Southeastern United States, you’re probably enjoying even cheaper gas, due to lower gas taxes and proximity to Gulf Coast refiners. Some liken these savings for families as a tax cut.
Even a decline in stocks is an opportunity for investors with a long-term buy and hold strategy who utilize a dollar cost averaging strategy, which refers to consistently investing in stocks at regular periodic intervals. This allows you to purchase cheaper shares as the market declines and fewer shares as markets rise. With, this is a powerful way to compound returns. No one knows for sure where the market will go next week, or even next year, but the long-term track record for stocks has a clear trajectory-up.
Further, the volatility we’ve seen in the stock market over this past year is more the norm than the exception. The stock market averages a correction every 30 months and they generally last two months or less.4 Before the big market drop last August we hadn’t experienced a correction since the financial crisis so it’s natural that a resumption to normal volatility takes some getting used to. Remember the adage by investing legend Warren Buffett says to ‘be fearful when others are greedy and greedy when others are fearful’.
How to Reduce Risk in Your Portfolio
Still, there’s no way to know if the sell-off will turn into a repeat of 2008. Here’s a couple ways to hedge exposure to stocks, which could help stabilize your portfolio while you sleep better at night. Consider adding alternative exchange traded funds to your portfolio which add a level of downside protection. One example is low-volatility’ ETFs. As the name implies, they tend to be less volatile than traditional stock portfolios due to their allocation to steadier, defensive sectors such as health care and consumer staples.
There are also funds that increase in value when the stock market goes in the tank. Known as inverse ETFs, they aim to deliver the opposite return of an underlying benchmark, such as the S&P 500 Index, for a single day. For example, if the S&P Index goes down 2% one day, an inverse ETF that tracks the S&P 500 will increase by 2% that day. These products may not be right for everyone, so always consult your financial planner, preferably a Certified Financial Planner, CFP. If the recent market volatility is really concerning you, you might want to reassess your investment risk tolerance which would mean a more conservative asset allocation strategy.