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Surviving Market Volatility

Joe DowlingNovember 2, 2018

Markets

Stock market volatility has been grabbing news headlines throughout the year as market gyrations seem to have condensed 2 years of price action into 1 year.  After a year of benign volatility in 2017, the market has been on a roller coaster of sorts. Many analysts had predicted an uptick in volatility, but this year’s market activity has tested even the patience and conviction of those professional investors with the most ice water in their veins. What is going on? And how does this recent volatility compare to similar, historical episodes?

This long-enduring bull market, which will turn 10 years old in March of next year, has been a dream for stock investors. From the March 2009 low of 666.79 to its all-time, intra-day high of 2940.91 on September 21 2018, the S&P 500 handed investors a whopping 341% nominal return.  But 2018 has brought many headwinds: a rise in interest rates (for the first time since January 2014, the yield on the 10 Year Treasury Note hit 3%, a key psychological level), fears of a global trade war, geopolitical tensions, and domestic political uncertainty in the run-up to the 2018 mid-term elections.

Although the market has corrected a handful of times during this bull market (the standard definition of a correction is a decline of 10% or more in an individual stock, index, or any asset traded on an exchange), 2018 stands out for having provided not one, but two, corrections to the S&P 500. Peak to trough, the January-February drawdown saw the S&P 500 lose 11.84% in 14 days (intra-day high of 2872.87 on January 26 to intra-day low of 2532.69 on February 9). The market subsequently began its climb to its all-time, intra-day high of 2940.91 on September 21st, a gain of 16.1%. Investors who exited the market in fear most likely missed out on the bulk of that upswing.  

What’s an investor to do?

Markets, in spite of what appears to be a chaotic and frenzied nature, typically trade and move in an orderly fashion and repeat similar patterns. Corrections are healthy for markets. They tend to weed out investors who have less conviction in their investments, while creating buying opportunities for investors who are able to take a cerebral approach. Exiting the market in fear, or trying to time the market, usually doesn’t work out too well for investors. In fact, selling too early and leaving money in cash could deprive investors of the opportunity to participate in potentially healthy market gains.

If you bought an S&P 500 index fund in 1998 and held it until the end of 2017, you’d have achieved a 301 percent total return. However, if you had missed just the five best days in that period, your total return would drop to 66 percent. If you missed the 20 best days in those two decades, your total return would be just 26 percent.

This is very relevant to today. October is no stranger to stock market volatility as it is the worst month of the year historically for equity returns. A contributing factor is that it precedes Election Day in early November, this year a midterm election. The flip side is that Novembers and Decembers of midterm election years have produced strong returns historically. Additionally, since 1952, the November to January period has been the best three months of the year.

What lies ahead?

Market fluctuations are inevitable and unavoidable. Is what we are witnessing the beginning of a bear market? History has shown that bear markets (a decline of 20% or more) typically start with more deceptive and less impactful drops, on average 4%. As an example, the 2007 selloff that heralded the global financial crisis and a 56.8% rout of the S&P 500 started with a 5% fall. What we do know is that we are in the midst of one of the longest economic expansions in history and the longest bull market for stocks. This too shall pass at some point.

In his book “Stocks for the Long Run,” now in its fifth edition, Wharton School professor Jeremy Siegel puts things in perspective. To him, it’s all about facts, not feelings.

Siegel points out that from January 1802 to June 2018, the compound annual real return for a broadly diversified portfolio of stocks averaged 6.6 percent per year after inflation. For long-term government bonds, the average real return was 3.5 percent. Gold averaged a 0.5 percent real return, just ahead of inflation.

“Stocks are indeed the best long-term investment for those who learn to weather their short-term volatility,” he writes in his book. “Investing over time in stocks has been a winning strategy whether one starts such an investment plan at the market top or not.”

Among the reasons Siegel sites as to why investors make bad decisions, being too emotional is at the top of his list. Siegel writes: “We find ourselves giving in to the emotions of the moment — pessimism when the market is down and optimism when the market is high. This leads to frustration as our misguided actions result in substantially lower returns than we could have achieved by just staying in the market.”

To be a successful investor, Siegel advises that managing expectations is imperative. Historical returns have averaged between 6 percent and 7 percent annually, substantially lower than what we have experienced in recent years.

History tells us there are likely to be more down and up days ahead in the stock market. But, Siegel argues, if you can ride out the storm, you’ll ultimately increase your wealth. If you have any specific questions about your portfolio, our advisors and dedicated investment team are willing and able to help you navigate through your situation (610-651-277).

Sources:

The Motley Fool Article – March 2018
USA Today Article – October 2018
Seeking Alpha Article – May 2017
NYTimes Article – October 2018
Wall Street Journal Article – October 2018
Daily Reckoning Article – October 2018
Barrons Article – October 2018
Think Advisor Article – October 2018
AdvisorStream Article – October 2018