Volatility, which had been fairly minimal the last 24 months, came roaring back over the last week. On Monday, the DOW experienced an 1,175 point drop, its largest single point fall ever. From a percentage perspective, the drop was 4.6 percent. While that also is significant, it was nowhere near a record.
The stock market’s pullback began in earnest last week, as rising bond yields and a stronger-than-expected pickup in wage growth led some investors to express concerns that a long streak of tepid inflation could be drawing to a close. Job gains in January, as reported last Friday, fueled those concerns, turning a spotlight on the Federal Reserve and its timeline for interest rate hikes, raising the odds the central bank will increase its benchmark rate in March. The report also offered more evidence that the U.S. economy is gaining strength with wages climbing at their strongest pace since 2009. The fundamental backdrop of the economy has not changed though; strong corporate earnings, positive economic data coupled with business-friendly tax reform. Roughly 80 percent of S&P 500 companies that have reported results for the fourth quarter have posted sales that beat analysts’ expectations, on track for the most positive surprises since at least 2008, according to FactSet.
WHY THE SELL OFF?
If the economic fundamentals are good, then why is the market selling off? As we have discussed individually in client meetings and in our ongoing communications, the market is trading at much higher multiples than historical norms. Secondly, the speed at which negative sentiment can perpetuate into the psyche of investors and ultimately the markets can be dramatic. This, coupled with emotional selling by investors focused on the short term, can create sizable market sell-offs. Lastly, volatility in the markets, although unnerving at times, is part and parcel of investing. We have not experienced this type of volatility lately so it feels different.
WHAT DOES “NORMAL” VOLATILITY LOOK LIKE?
JP Morgan maintains an interesting graph outlining intra-year volatility of the S&P 500 Index. On the graph, the gray bars represent the percentage return of the Index for that year and the red dots represent intra-year percentage drops of the Index. For example, in 1980 the S&P 500 Index returned 26 percent for the year but experienced an intra-year drop of 17 percent. In 2017, the index returned 19 percent but only experienced an intra-year drop of 3 percent, unusually low volatility. As noted on the graph, over the last 38 years (1980 – 2017) the average “intra-year drop” in the S&P 500 was 13.8 percent. Thus, in an average year the S&P 500 will drop almost 14 percent from its intra-year high to an intra-year low. Yet in 29 of the last 38 years the S&P 500 still realized positive returns for that year.
Over the last few days, the S&P 500 has dropped over 7 percent from its all-time high reached earlier this year, so nothing out of line. In the short term, we do not know how long the current turbulence will last. Regardless, we will continue to focus on exercising prudent and disciplined judgment in managing client investments.
Staying disciplined to our investment principles is what allows us to act differently than the crowd and be able to focus on the long-term goal of growing your investments and achieving your financial goals.
In closing, we would like to reinforce that events like this will happen. In fact, we should all expect it. At times like this, we continue to recommend patience and discipline. However, we recognize that knowing volatility will happen does not remove the human emotional element of fear and concern that can arise during unpredictable market swings.
Please let us know if you have any questions or would like to discuss in more detail.