Over the last two months, the pendulum of stock market volatility has swung from extreme stability to extreme fluctuation. For well over a year, the investing public has been lulled into a sense of security by a combination of near nonstop advances accompanied by relatively mild day-to-day changes. From a naïve perspective, it really doesn’t seem to get much better than that.
In February, however, it appears as if someone hit the power button, setting the stage for a regular flow of triple-digit daily price changes. Years ago, one-day changes of 100 points or more on the Dow Jones average were viewed as quite dramatic. Of course, that was at a time when the Dow was far below current levels. These days, with that indicator near the mid-20,000s. few people are paying much attention unless we got up in the 500-1000 point range . . . which we have on several occasions over the last month or two.
Back at the turn of the millennium, a book entitled “Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market” was published. That was just about the same time stocks began to hit the skids, following the excesses of the dot.com era. Yet, here we are almost two decades later and the 36,000 mark is but a 50% advance away.
The bigger issue is how to position portfolios to handle the shocks of daily ups and downs. One of the more useful approaches is to bulk up holdings of noncorrelated investments, those that don’t move hand-in-hand with the stock market. These would include fixed-income securities (bonds or bond funds) and alternative investments.
In the area of fixed income, risk and volatility will be lower for short-term maturities, especially those of higher quality. It may be worthwhile also to consider deep-discount closed-end bond funds. Some are selling at or near their greatest undervaluation relative to their net asset value and at the same time provide current yields in the high single digits. Among the alternatives, consider long-short funds, covered-call funds, and covered-put funds.
Spreading allocations across a variety of asset classes is akin to putting a good set of shock absorbers on a car. The engine (equity holdings) pushes you forward and the shock absorbers (fixed income and alternatives) help smooth the ride along the way.