Finance, Stocks

How to smooth out the Market’s Bumpy Ride?

The Wall Street scare that spooked investors in February proved to be a false alarm showing how risky it can be to abandon stocks altogether out of fear.

But it was the start of something. Though the sellout didn’t turn into a bear market, stocks have entered a new, bumpier stretch.

Volatility returned in the first quarter of 2018 with a vengeance,” says David Kotak chairman of Cumberland Advisors.

Less than three months into this year, investors have already witnessed more days in which the S&P 500 index has risen or fallen by at least 1% than in all of 2017. What’s more, the average daily swing in stock prices so far in 2018 has been three times wider than last year — meaning there’s a good chance that any given day might produce a triple-digit gain or loss in the Dow.

That volatility is likely to remain for the foreseeable future, market strategists say.

Why? For starters, at nine years old, this is the second-oldest bull market in history. And aging rallies have a way of getting jittery near the end.

Moreover, “the market is reacting to the uncertainty around this president’s style,” Kotok says, noting that the unpredictable nature of this administration — coupled with disruptive turnover among White House personnel — could be contributing to the market’s skittishness.

Plus there are plenty of fundamental reasons why investors are getting nervous. Among them: rising interest rates, which could increase borrowing costs for companies; rising inflationary pressures, which could force the Federal Reserve to hike interest rates even more; and fear of a trade war, especially now that the Trump administration is about to impose tariffs on Chinese imports.

Yet all the while, the bull market keeps plodding along, which means you have to find a way to smooth out the market’s bumps without slamming the brakes on stocks.

The good news: There are some investments act like shock absorbers if held within a diversified portfolio.

1. ‘Steady Eddie’ Stocks

The most straightforward strategy to reduce volatility in your portfolio is to stick with so-called Steady Eddies: shares of humdrum companies that tend to fall less when the market is down, but also rise less in euphoric times.

While this seems like a strategy tailor-made for rocky markets, there’s a strong case for owning these shares all the time. Academic research has shown that low-volatility stocks actually outperform the broad stock market over the long run.

Moreover, low-volatility stocks have outperformed the market in the two most recent significant downturns for U.S. equities: the bursting of the dotcom bubble and the global financial crisis.

In the 2000-2002 tech wreck, for example, low-volatility stocks actually gained more than 6% while U.S. stocks fell by double digits.

How to invest: Some funds and ETFs specifically focus on this low-volatility strategy. iShares Edge MSCI Minimum Volatility(ticker symbol: USMV), for instance, is a big, low-cost fund that invests in about 150 U.S. stocks that exhibit lower-than-average volatility while also enjoying strong profit and cash flow growth.

Among the top holdings of this fund are boring names like the medical instrument maker Becton Dickinson and the trash and environmental services firm Waste Management. In the 2008 stock market crash, Becton Dickinson fell only about half as much as the broad market while Waste Management shares actually gained value.

Thanks to these types of stocks, iShares Edge MSCI Minimum Volatility tends to hold up better in choppy markets. In months when the S&P 500 has posted losses over the past five years, for instance, this ETF has lost only about two-thirds as much as the market, according to the fund tracker Morningstar.

2. Dividend-Paying Stocks

Income-generating stocks have a built-in cushion: the dividends that they issue to shareholders.

If their share prices were to fall say, 10%, a dividend payout of 3% would alleviate some of that pain. In the 2008 market crash, for example, when the S&P 500 index lost a stunning 37%, dividend payers saw a much more modest 23% decline in total returns, softening the blow.

There’s another reason to embrace dividend payers at a time when market volatility is on the rise due to inflation fears: “Over the long term, dividends have done a good job of staying ahead of inflation,” says Jack Ablin, chief investment officer for Cresset Wealth Advisors.