On Thursday the market downturn struck the staid Wall Street with a dose of turbulence, and some investors certainly want to go into calmer times soon.
Volatility in the stock market refers to how much a stock or index moves on any given day. Many investors consider low volatility plays to be less risky than other bets, but the upside during strong market periods may be limited.
As a result, many investment firms have developed products, such as exchange-traded funds (ETFs), that aim to be less volatile than the broader market.
The Invesco S&P 500 Low Volatility ETF (SPLV) is one option, as it seeks to hold the 100 least volatile stocks in the broad market index. Morningstar gives the fund a four-star rating, and its top holdings include Colgate-Palmolive, PepsiCo, and Verizon.
Blackrock’s iShares MSCI USA Min Vol Factor ETF (USMV) and State Street’s SPDR SSGA U.S. Large Cap Low Volatility Index ETF are two other popular funds for large cap stocks with low volatility (LGLV).
On Thursday, all three funds outperformed the S&P 500, and they also outperformed the broader market in September and October of last year, when the S&P 500 fell 6.6 percent following its summer rebound.
Dividend funds are another popular play during volatile periods, as investors try to lock in income when price returns are uncertain. During the fall downturn, the Vanguard Dividend Appreciation ETF (VIG), for example, outperformed the S&P 500.
To be sure, low volatility strategies can be overwhelmed by sharp market declines.
Between February 20 and March 23 of last year, as the coronavirus pandemic spread rapidly in the United States and Europe, the S&P 500 fell by more than 33%. The iShares low volatility fund outperformed the benchmark index only marginally, while the Invesco and SPDR funds fell even further. The Vanguard dividend fund fell 31%.
Morningstar’s Ben Johnson, director of global ETF research, stated that “low volatility doesn’t mean no volatility,” and that low volatility ETFs have seen large outflows over the past year, implying that investors were dissatisfied with the performance in 2020.
“At the end of the day,” Johnson said, “these are still stocks you’re investing in.” “While these funds may be less volatile than buying a broad market index fund, they will still be a lot more volatile than a bond fund.”
If investors want to be more aggressive in avoiding stock market risks, there are non-traditional strategies and bond-heavy funds that can help diversify portfolios.
Amplify’s BlackSwan Growth & Treasury Core ETF (SWAN), which invests primarily in U.S. Treasury securities. On Thursday, Treasuries plus call options on the S&P 500 to capture equity upside outperformed the equity markets and low-volatility ETFs.
The fund had also been steadily rising recently, rising 10 times in 12 sessions, as some investors may have become concerned about the market’s record highs.
The market pullback
Jeremy Siegel of Wharton School stated that the equities are still solidly in a bull market, but thinks that investors should be prepared for further pullbacks like Thursday while the Federal Reserve pursues the global economic recovery.
The prominent finance professor’s comments on analysts’s “Closing Bell” came as all three major U.S. equity indexes were off their day’s lows, but still in the red. The Dow Jones Industrial Average fell nearly 260 points, or 0.75 percent, while the S&P 500 and Nasdaq were down 0.86 percent and 0.72 percent, respectively.
Concerns about potentially slower economic growth and the threat of the Covid delta variant weighed on Wall Street on Thursday, especially in light of the decision to ban all spectators at the Olympics in Tokyo.
However, Siegel believes that the biggest risk to the stock market in the future is not the delta variant delaying a pandemic recovery. Rather, he stated that it is inflation data and its implications for the Fed’s monetary policy that he is concerned about.
“I don’t believe the bull market is over. There will be more hiccups as the Fed adjusts to the reality that they will have to start tightening,” said Siegel, who correctly predicted last month that members of the Fed’s policymaking arm would move up their timeline for raising interest rates from near-zero levels.
For months, Fed Chairman Jerome Powell and other central bank officials have maintained that the inflationary pressures seen in the United States are temporary, stemming from the unprecedented economic reopening following numerous pandemic-related disruptions.
As a result, Powell believes the Fed’s highly accommodative monetary policy remains appropriate and necessary to assist the United States’ labor market in healing after millions of Americans lost their jobs as a result of the Covid crisis.
Siegel is among those who believe the Fed is making a mistake by maintaining its emergency policy stance, which includes at least $120 billion in asset purchases each month in addition to near-zero interest rates.
Siegel told analysts that he is looking forward to the Consumer Price Index report on Tuesday, followed by the Producer Price Index on Wednesday. He believes the CPI, in particular, has the potential to be a “market-moving event” if it comes in higher than Wall Street expects.
“If we had a really hot CPI and the day after PPI, I wouldn’t be surprised if we got some announcement at the next Fed meeting — at the latest, I believe it will be August — when we’ll get that tapering move,” Siegel said.
The Federal Open Market Committee will meet on July 27 and 28. The Fed’s annual economic policy symposium is scheduled for August 26-28 in Jackson Hole, Wyoming.
“I believe inflation will be very hot, and I believe the Fed will be forced to respond sooner than many people believe, at least at this point,” Siegel said.
Siegel believes that if the Fed “sensibly” changes its stance on inflation being transitory, the market will “say they’ve caught on.” They will be walking a tightrope with the data that will be coming in over the next few months.”
In contrast, the professor and long-term bull said he sees risks to the market if that does not happen.
“We are still making good progress. The question is, is the Fed delaying so long that it will have to withdraw too sharply later?… Aside from that, I believe stocks, you know, earnings are blockbuster and will continue to be blockbuster this year, supporting it.”