After peaking on April 23, equity markets have experienced an unfortunate downward spiral precipitated by worries about the European sovereign debt crisis and fears of a global double-dip recession. In a flash, the euphoria of recovery was dispelled as the significant burdens of fiscal deficits took center stage. While swelling debt burdens have been an intermediate-term issue for most developed nations, investors have doggedly refused to wait that long for a solution, and demanded instant gratification, or else.
Still, just as quickly, with the advent of corporate earnings season, the markets reversed course, erasing losses after savvy corporations proved by posting positive results that they could handle the economic cycle of boom and bust with aplomb.
While most advisors are comfortable and even adept at managing through the ups and downs of normal market cycles, the market gyrations in recent years have taken a radical turn. Volatility has become the new normal. So have market panics.
Why? One has only to tune in to the hysteric cacophony at media outlets like CNBC, where a prominent economist such as Nouriel Roubini can get his heavily researched opinions reduced to ten-second sound bites that win him the catchy moniker "Dr. Doom."
Besides the rapid and sensationalist news flow, market panics have also been spurred by a technology driven rise in liquidity. Case in point: the so-called "flash crash" of May 6, 2010, which saw the market swing 1,010 points. The real reasons for the crash remain mysterious, but they were without a doubt exacerbated by massive algorithmic trading and the confluence of different exchanges used by investors large and small. Of course, trends in product development also fuel the proverbial fire of market panics, as evidenced by the rise and widespread use of double-levered directional ETFs or the appropriation of traditional hedging tools such as credit default swaps by speculators.
One of the tried and true ways for advisors to cope with heightened market volatility and episodes of market panic is to cling harder to the principles of long-term investing and stay the course. It's a valid and worthwhile approach that has worked in the past to be sure. Yet it would seem that in this new rapid-fire world of information and technology, complacency is the enemy of successful investing.
Furthermore, in the aftermath of the "lost decade" of U.S. stock returns from 2000 to 2009, frustrated clients want to trade more frequently and opportunistically, tax consequences be damned, by timing markets to avoid short-term losses and realizing profits when they can rather than sitting still and watching them slowly disappear. But it's difficult to successfully trade and time markets in the short term, so advisors are reticent to do it, and have instead turned to the multitude of products designed to hedge market risk.
Unfortunately, when so many advisors and asset managers turn to the same hedges, these options often fail to be effective. They reflect panic pricing just as much as the assets they're intended to hedge.
So what is the solution to surviving and thriving in an investment world where market panics are increasingly commonplace and market volatility is exceedingly high? There are no easy tricks or antidotes, but consider these three relationship management techniques to avoid being caught in the crosshairs.
Bench Your Benchmarks
To be sure, benchmarks are an important tool of money management to track returns and compare performance objectively on a short-term and long-term basis. However, it is often easy for clients and advisors alike to live and die over benchmark performance comparison, and they get misguided in their investment efforts as a result. Better instead to establish and articulate your clients' lifestyle goals, and manage accordingly. Instead of trying to beat this index or that benchmark, manage your client's assets to make sure she has X dollars in liquidity, Y dollars in income and Z dollars in investments that deliver a growth rate commensurate with her objectives for the money.
For some clients, the process could even be as simple as setting a dollar amount goal to be achieved over a period of time, and conversely setting a dollar limit that assets should never fall below. Whatever form it takes, reinforce those lifestyle goals and objectives at every opportunity as you review performance results. While it is unrealistic not to include any objective barometer of performance, benchmarks should be a talking point, not the final measure.
Turn On A Tactical Tranche
Another way to help cope with market volatility is to embrace it-at least in a measured, modified way. Trading is for traders, but you can strike a balance between short-term plays and your long-term investment horizon.