What Causes Volatility in the Markets?

If you pay any attention to the stock market, you probably know it can be volatile. Over the past decade, we have seen the Great Recession all the way to new record highs for stocks. And there have been a lot of ups and downs in between. 

Though this can be nerve-wracking for investors, fluctuations are actually a normal part of investing. Often, stock prices are volatile when something unexpected happens. Here are the most common examples of what can lead to a shake up in the markets. 

1. POLITICAL DEVELOPMENTS

   It’s easy to see why politics play a big factor. After all, the government plays a major role in regulating industries and impacts the economy overall when it makes decisions on things like taxes, tariffs, trade agreements and federal spending. Wall Street takes its cue from politicians when it’s trying to predict how policy — rumored or real — will impact business. Everything from speeches to legislation to elections could cause knee-jerk reactions among investors.

   Case in point: When Donald Trump pulled off a surprise upset over Hillary Clinton in the 2016 elections in the wee hours of November 9, 2016, world markets panicked overnight, dropping sharply before shooting back up hours later after Trump said he’d focus on economic policy in his victory speech. More recently, when President Trump announced tariffs in March on imports from China as part of an escalating trade war, the Dow, S&P 500 and Nasdaq all tumbled more than 2 percent. Since then, Trump has gone back and forth on his stance, but the White House’s recent announcement that it would move forward with the tariffs contributed in part to Tuesday’s market volatility.

2. ECONOMIC INDICATORS

   Just the way a doctor might get a snapshot of a person’s health based on a pulse or blood pressure readings, economic data offers a window into the health of the overall economy. When the economy is doing well and hitting targets, the market tends to react positively. When targets are missed, the markets may tumble. This is why economic reports are often awaited with bated breath.

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   Monthly jobs reports, inflation data, consumer spending figures and quarterly GDP calculations can all impact market performance. Typically, traders price what they expect these reports to say into stocks prior to the reports coming out. For instance, if traders expect GDP to rise by a quarter percent, they will trade stocks at prices that reflect the increase in the days and weeks leading up to the report being released. If the report is different than the expected number, the market may quickly fluctuate.

3. PUBLIC RELATIONS HITS AND DISASTERS

   Sometimes volatility isn’t market-wide; an individual company can see its stock performance take a hit or climb based on whether it’s getting good or bad PR that day — and depending on how large the company is, its performance can have a greater effect on the markets. News that paints a company in a positive light, such as a strong earnings report or a new product that is wowing consumers, makes investors feel good about the business, so they may flock to it and help raise the stock price. On the flip side, negative press, such as a product recall, data breaches or bad executive behavior, can hurt a stock price as investors sell off their shares.

   For instance, last November, when Apple released the iPhone X, it coincided with a better-than-expected quarter for them, and shares opened 3 percent higher the morning the product hit the shelves. Compare that to when reports surfaced that Facebook had allowed Cambridge Analytica to mine users’ data without their knowledge. The company’s shares dropped steeply, and both the tech sector and the major indexes felt the ripple effects.

4. VOLATILITY OVERSEAS

   Today’s economy is more globally connected than ever, and that means what happens in the world has a major impact on what happens at home. War, political upheaval, rebellions, regime changes and the like have the potential to impact trade, multinational corporations and the flow of money and investments between countries. So when there is even a hint that something might be brewing on the international stage, it can cause markets to swing.

   For instance, Italy’s current political crisis, in which a new government has yet to form despite elections in March, was also a factor in Tuesday’s volatility. Or take Brexit. When people in the U.K. surprised the world by voting to leave the European Union, the Dow lost nearly 900 points in the two days following the vote. And it dropped more than 100 points a few hours after North Korea launched a missile over Japan in August 2017.

So how can you keep from panicking when market volatility ticks up? For starters, it’s important to realize that volatility comes with the territory when you decide to invest. The stock market will always have its ups and downs, and there’s no use trying to predict what’s going to happen. So if you’re investing for the long term, consider basing your decisions on your timeline and tolerance for risk, rather than on what’s happening in the markets from one day to the next. Also, remember that being diversified is one way to help manage your exposure to volatility. By spreading your money out over various asset classes you’re also spreading out your market risk, and ensuring your portfolio’s results aren’t based on the performance of one type of investment.

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No investment strategy can guarantee a profit or protect against loss. All investing carries some risk, including loss of principal invested.

Past performance is no guarantee of future results. Examples are for illustrative purposes only and not indicative of any investment.