Why Everyone's Talking About… Market Volatility
Bonds, traditionally viewed as a safe haven, have fared even worse: having booked a -10% loss for the first quarter, you’d have to go back to 1842, in the midst of a depression, to find a year in which global bonds slumped more.3 For the first time since 1994, stocks and bonds sold off together, and the trusty 60/40 portfolio, long a cornerstone of diversification, endured one of its worst periods ever.4 Few assets have been left unscathed, and even experienced hands are feeling the pressure.
“My abdomen is churning all day,” said one veteran bond chief.5 “There are so many crosscurrents of uncertainty, and we aren’t going to get closure on any of them for weeks, if not months.”
In the last 140 years, in fact, there’s been 19 stock bear markets, with an average decline of around 37%.6 Such downturns tend to be tamer outside of recessions, with falls around 20%.7 If inflation moderates and we do avoid recession, the worst may already be behind us – especially since most of the sell-off has happened as a result of rising rates (the ‘P’), rather than cratering profits (the ‘E’).
In addition, most bear markets are over relatively quickly anyway, with losses eventually recouped: S&P 500 bear markets tend to last around a year, with investors breaking even after just over two.8 And the recent turmoil comes after a truly epic bull run: even if the most bearish calls of 3400 on the S&P 500 are realised, that would still only take us back to late 2019, just before the pandemic hit.9
For those that have been invested for years, 2022 could prove another blip like 2008, 2018 or 2020.
And no matter how scary things seem, investors can find comfort in the fact that stocks usually prove more resilient than they suppose, rising steadily over time – despite various wars, pandemics, natural disasters, financial meltdowns, monetary resets, and recessions. Even the great inflation shock of the 1970s, which saw inflation peak at 14% and stocks tread water for over a decade, was eventually followed by one of the greatest bull markets of all time in the 1980s.10
Would-be investors, meanwhile, may even see the extreme pessimism as an opportunity; as Warren Buffet famously said, ‘the trick is to be fearful when others are greedy, and greedy when others are fearful.’ That certainly rings true now. Picking turning points is notoriously difficult, if not impossible, but putting money to work when there’s ‘blood on the streets’ has shown to work time and time and again. It’s no surprise the Oracle of Omaha himself is dipping his toes into this market and adding positions after sitting on a mountain of cash for years.
Yes, the first half of 2022 has been historically bad for investors. Yet history also shows that these times pass. Panicking or extrapolating current woes into the future ad finitum is a fool’s errand.
“One major reason that investor returns are considerably lower than index returns has been the fact that many investors withdraw their investments during periods of market crises,” they wrote. “Since 1984, approximately 70% of this underperformance occurred during only ten key periods. All of these massive withdrawals took place after a severe market decline.”
Perhaps this is to be expected. Human beings, after all, are emotional creatures, and very few of us can remain unaffected by the animal spirits of fear and greed – forces that dominate markets. However, the more we overestimate our ability to time markets or act on impulse or emotion, the less likely we’ll succeed in meeting our goals.
“Your money is like a bar of soap,” famed economist Gene Fama Jr. once said. “The more you handle it, the less you’ll have.”12
Instead, staying the course and doing nothing should be thought of as a conscious decision. If you’ve got a long-term plan or professional adviser guiding you, then short-term sentiment and market swings simply shouldn’t matter. It’s developing a plan – and, most crucially, sticking to it – that gives investors the greatest chance of compounding returns, even if it can feel uncomfortable at times.
“Typically… [those with little composure] give up long-term performance to seek short-term comfort,” explained Greg Davies, head of behavioural science at Oxford Risk. “People say, ‘They’ll sit on the side until I’m comfortable again’ – but you won’t feel comfortable until well after the fact.”13
For everyone that has timed the market and won, there’s plenty more who have missed the rebound and lost out – as the rapid bouncebacks in 2018 and 2020 showed.
Between the start of April and mid-May, stocks experienced seven weeks in a row of near continuous selling, the second longest period on record going back to 1928.14 That’s seen stocks in Europe and China dip below their long-term average valuations, and the US stock market just slightly above its 10-year average forward price-to-earnings ratio (at late May). Finally, it seems, the risk-reward is beginning to brighten.
Just as important is the extreme pessimism now pervading markets. Fund managers are holding the most amount of cash for 20 years – a huge sign of trepidation – and survey and sentiment indicators, such as Fear and Greed polls, are so bad they’re screaming ‘buy’.15
This doesn’t mean a bottom or rally has to happen, though historically it’s paid to invest when sentiment is extremely poor. But it’s notable that shrewd investors like Warren Buffet are beginning to put money to work and, in another optimistic sign for investors, corporate insiders are finally starting to purchase their own stock.16
That’s good for a couple of reasons.
First, it shows that insiders now think their own companies are cheap or offer compelling long-term value going forward. And second, insiders are often considered the ‘smart money’ that know their business, and its prospects, inside out; it pays to invest alongside them when you can. Conversely, the record number of insider sales when stocks hit their highs in 2021 should have come as a warning sign.17
For those that can temper their emotions, adopt a long-term timeframe, and go against the grain, dollar cost averaging now may seem an astute strategy. If things do get worse, losses are kept to a minimum, and you can buy assets at cheaper prices in the future without trying to time the market.
Ultimately, it’s important to keep perspective – especially during difficult times like 2022. Resisting the urge to do something is often crucial. History shows it’s investors, not markets, that are their own worst enemy.
Diverse minds fuel insightful ideas. And ideas mean opportunities.
- Bull market – A bull market is a period of time when the price of assets rise continuously. The commonly accepted definition of a bull market is when prces rise by at least 20%.
- Bear market - A bear market is typically defined as a market that falls more than 20% from its most recent peak.
- Volatility – Volatility is the rate at which the price of a particular asset increases or decreases over a particular period. Higher stock price volatility often means higher risk.
- 60/40 Portfolio – a mix of 60% stocks and 40% bonds, or something close to it. The portfolio has both offensive (stocks) and defensive (bonds) characteristics and generated stable growth and steady income.
2 Source: Global equity data sourced from Bloomberg, May 2022.
3 Source: Wall Street Jounal, https://www.wsj.com/articles/its-the-worst-bond-market-since-1842-thats-the-good-news-11651849380
4 Source: Barrons, https://www.barrons.com/articles/stocks-bonds-portfolio-investing-51652394644
5 Source: Wall Street Journal, https://www.wsj.com/articles/the-market-is-melting-down-and-people-are-feeling-it-my-stomach-is-churning-all-day-11653105601
6 Source: Marketwatch, https://www.marketwatch.com/story/based-on-19-bear-markets-in-the-last-140-years-heres-where-the-current-downturn-may-end-says-bank-of-america-11651847842
7 Source: CBS News, https://www.cbsnews.com/news/bear-market-2022-stock-market-wall-street-money/
8 Source: OPB, A Bear Market May be On the Horizon. Here’s What That Means https://www.opb.org/article/2022/05/19/bear-market-may-be-on-horizon-what-that-means/
9 Source: Global equity data sourced from Bloomberg, May 2022.
10 Source: Yahoo Finance, https://finance.yahoo.com/news/day-market-history-1980s-bull-112200931.html
11 Source: Dalbar, 2020 QAIB Report, https://wealthwatchadvisors.com/wp-content/uploads/2020/03/QAIB_PremiumEdition2020_WWA.pdf
12 Source: The Balance, https://www.thebalance.com/why-average-investors-earn-below-average-market-returns-2388519
13 Source: Irish Times, https://www.irishtimes.com/business/personal-finance/does-gut-instinct-betray-us-when-it-comes-to-investing-1.1431879
14 Source: Financial Times, https://www.ft.com/content/c017c45f-bfc5-4fce-a0fe-5c60b8fafe50
15 Source: CNN, https://edition.cnn.com/2022/05/18/investing/premarket-stocks-trading/index.html
16 Source: Financial Times, https://www.ft.com/content/2118d608-214a-475a-afcb-1882c23b6f50
17 Source: CNBC, https://www.cnbc.com/2021/12/01/ceos-and-insiders-sell-a-record-69-billion-of-their-stock.html
This material is provided for informational purposes only and should not be construed as investment advice. Views expressed in this article as of the date indicated are subject to change and there can be no assurance that developments will transpire as may be forecasted in this article.