Advisers on stock sell-off: Keep calm, keep diversified

Some embracing decline and accompanying volatility to put cash to work

By Jeff Benjamin

Oct 10, 2014 @ 12:01 am EST

Just because the stock market hasn't seen a major pullback in a while doesn't mean the resurgence of volatility should send investors ducking for cover.

In fact, many investment advisers are embracing the recent market ride, which has included the Dow Jones Industrial Average's drop on Thursday of more than 300 points.

“We're not really worried about it; we actually need a little pullback, because we need some opportunities to restructure and buy into the market,” said Andrew Rice, chief financial officer at Money Management Services Inc.

Mr. Rice said he wouldn't be surprised to hear that panicked investors were inundating their advisers with calls after a week of 200-plus-point swings by the Dow. Mr. Rice is already looking for areas to start placing client cash positions of between 5% and 10%.

Bill Ennis, a partner at the advisory firm of Day & Ennis, said he has taken some recent calls from nervous clients but he's talking them down by showing his own sense of calm.

“We've inured to the fact that October is known for being a volatile month for stocks,” he said. “Our expectation is that the volatility could continue through the balance of the quarter, or at least through the November elections.”

Despite the big numbers, the recent moves on a percentage basis are actually not too far out of line with historical norms, according to Paul Schatz, president of Heritage Capital.

“The market volatility is still below historical norms, because we should be having 100- to 300-point moves every day,” he said. “The Fed's interest rate policy has dampened volatility, but investors need to expect volatility to start returning to normal levels as short-term interest rates start to go up.”

That normal level, he said, will be represented by daily market swings of between 1% and 1.5%. At the close of trading Thursday, the Dow, S&P; 500, and Nasdaq Composite indexes were all down by between 1.97% and 2.07%.

Based on historical market patterns, Mr. Schatz acknowledged a slight chance of a pullback of between 8% and 11% this quarter. From the Dow's mid-September peak of 17,280, a correction of that magnitude would take the blue-chip barometer down to between 15,379 and 15,898.

On Thursday, the volatility of the S&P; 500, as measured by the VIX, reached 19.38 before settling down to 18.76, which was a 24% increase for the day. That compares with a recent bottom of 10.2 in July. Mr. Schatz said he believes market volatility will settle back toward the mid-teens by early next year on the way to a new market high.

“Right now, I think people can shrug this off as a routine, normal and healthy pullback,” he said. “I think we bottom this month, then we go back to new all-time highs this quarter.”

Jay Batcha, founder and chief investment officer at Optimal Capital Advisors, is attributing the new level of volatility to simple math. But that doesn't mean he or his clients have any reason to run scared.

“It's been a long time since we've experienced this kind of volatility,” he said. “Right now, margin levels are at all-time highs, and when people get spooked, there's a lot of panicky selling that can happen as they draw down their leverage.”

Mr. Batcha said he is a big believer of diversification across multiple asset classes, including alternative investments, which are part of his conversation with clients when things start to look choppy.

“We don't pretend to know when things will turn around, but we know a pullback is way overdue,” he said. “There have been a lot of quantitative and psychological metrics that have pointed out it's not a good time to buy.”

Portfolio manager Keith Trauner of Goodhaven Funds would beg to differ.

“Volatility is a friend of a patient and liquid investor,” he said. “This type of environment where volatility starts to reappear is good for us, because we need volatility to buy and sell advantageously.”

Mr. Trauner added that he won't try and predict market outcomes, but that he is “cognizant of the historical outliers in this market.”

In other words, he wouldn't be surprised to see more volatility ahead.

“We're very convinced we're buying value today,” he said. “We don't know if this is the start of a much bigger correction or a downturn, or if it has run its course, but we do know we will be eventually rewarded for what we're buying today."

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