After years of abnormally and historic low market volatility that lulled many investors into believing (again!) that markets only go up, market fluctuations are now are providing a healthy reminder that market corrections are a normal part of investing. Remember, however that like food, some healthy things don’t taste good in the short run, but are beneficial in the long run. Eat your broccoli!
An increase in volatility shouldn’t be a surprise. Wages are increasing, inflation expectations are rising, the market hit many new highs in the last year, and the VIX volatility index was under 10 over 50 times in 2017, whereas the next highest was 1993 with only 4 days under 10. Also in 2017, for the first time ever, the S&P was up every month… that’s simply not normal. For quite some time, in our Quarterly Context webinars, we’ve been reminding clients to expect an increase in volatility.
In our view, these fluctuations are not a test of the markets. They are an investor test. Those that understand history respond differently to the present. Those that are greedy or are “skilled forgetters” who over-estimated their risk tolerance or resisted maintaining a spending cash reserve and instead chose to take more risk than was needed to accomplish their goals, are now reminded of the pangs of avarice. These problems are uncommon amongst our clients, but are very common in the general public.
Unfortunately, even if the economy is fundamentally sound, and even if our clients are focused on staying the course, emotional investors in that general public can cause swings in the market that make others nervous.
There’s no doubt that market corrections can be unnerving, but they’re a healthy part of the economy and market system. The following perspective may help:
- Headlines yesterday exclaimed that the market experienced the largest point drop in history. But, remember, points are not percentages. On a percentage basis, yesterday’s 4.6% drop (as measured by the Dow index, whereas the S&P 500 fell 4.1%, Nasdaq fell 3.8%) would rank 108th Not a good day, but nowhere near the worst day.
- Since 1928, the market has suffered an average of 3.4 annual drops of 5% or more.
- Market corrections, as defined by a drop of 10% or more, are common. Global stock markets have fallen from peak-to-trough by more than 10% in two-thirds of all years since 1979. Yet, most of those years still posted a positive return for the full year.
- Since the last correction was the Global Financial Crisis, where US stocks dropped over 50%, people may incorrectly assume that volatility always leads to catastrophic drops. They don’t. More typically, corrections last anywhere from 20 trading days (the 1997 correction, down 10.8%) to 104 days (the 2002-2003 correction, down 14.7%).
- It is the very existence of volatility that helps create higher long-term returns. The stock market must provide higher returns than bonds or cash, over time, to attract and reward investors. The relationship between risk and reward is a fundamental part of the economy and investment principles.
- Volatility provides attractive buying opportunities for those who are in accumulation phase, and to people and organizations in all stages, through rebalancing. We have regularly rebalanced our clients over the years, and as a result, the impact of volatility is also reduced, and long-term returns are boosted.
Since past is prologue, it is likely that will stocks remain volatile for a period of time, and it may get worse before it gets better. Remember, however, that rebounds are also inevitable, often rapid, and unpredictable.
As long-term investor Warren Buffet once wisely said, “The stock market is a device to transfer wealth from the impatient to the patient.” Do you want to be in the panic group or the profit group? Investors need to make a rational and intentional choice, rather than letting emotions dictate outcomes.
If your goals have changed, or you want to change your goals, it is always the right time to discuss a change to your investment strategy. Otherwise, when there is a storm, it generally makes sense to remain in your house, rather than scrambling to get outside, and abandoning a structure designed to weather the elements over time.
For an education video, including how to think about market volatility, on The Advisory Group’s “WealthStep” site for 401k plans and smaller investors, which may be helpful to you, plan participants, friends or family members: YouTube