Volatility is Back
If you are feeling a little uncertain about the markets you are not alone. The S&P 500’s April return of -8.7% was the 14th worst month since 1970. You would have to go back to March 2020 (the very beginning of the pandemic induced Bear market) and September 2008 (the height of the financial crisis) to find worse months. In fact, September 2008’s decline of -8.9% barely eclipsed April’s descent. In addition, the US Dollar has continued to strengthen, which has had a negative impact on international equity returns.
In fixed income, only cash has experienced a (slight) positive return over all time periods shown with 1-5 Yr TIPS increasing by 0.2% for the last 3 months and 2.7% for the last 1 yr. Yields have risen across the Treasury curve as expectations for interest rate increases mount. For example, the 10-year Treasury rose from 2.32% on March 31 to 2.89% on April 29 and is now trading above 3%. According to the Wall Street Journal, this was the largest monthly increase in the 10-year Treasury since December 2009.
Keeping things in perspective, a simple portfolio consisting of 60% MSCI ACWI and 40% Global Agg Hdg USD is down -10.7% through the first four months of 2022. This same portfolio was down -12.6% for the first three months of 2020, the beginning of the global pandemic. While no one likes to see negative returns, it is a good reminder to clients that we have been through tough markets in the recent past.
Despite the recent volatility, the 3 year return for the S&P 500 is still 13.8%, the 5 and 10 year are both 13.7%. Periods of negative returns are common and expected, but don’t forget all the good periods too.
What is Causing the Volatility?
Uncertainty around the war in Ukraine as well as the Fed’s decision to increase interest rates is fueling the recent market decline. In response to the highest inflation we have seen in 40 years, the Federal Reserve is increasing interest rates and tightening the money supply. This is the best way to vanquish inflation and cool off the rapid rise in prices across all the goods and services we consume. The market is digesting this and has been volatile as a result.
Some people think the stock market doesn’t go up when interest rates rise. Since 1983 we have experienced six periods of time when interest rates went up. The average return of the S&P 500 during those periods has been 9.5%.
What Should Investors do Now? Should we sell and go to cash because of the market decline?
When you look at things in perspective, the market has responded very well following periods of decline. In fact, the average return 1-5 years after a 10% decline is between 10-11% per year. If you sell and go to cash, you will not experience the periods of growth that tend to come right after market declines. The great companies of the world that you own are very resilient and are hard at work figuring out how to get through the current period. See below for some historical data on how the market performs after a 10% decline.
Sudden market downturns can be unsettling. But historically, US equity returns following sharp downturns have, on average, been positive. A broad market index tracking data since 1926 in the US shows that stocks have tended to deliver positive returns over one-year, three-year, and five-year periods following steep declines. Cumulative returns show this to striking effect. Five years after market declines of 10%, 20%, and 30%, the cumulative returns all top 50%. Viewed in annualized terms across the longest, five-year period, returns after 10%, 20%, and 30% declines have been close to the historical annualized average over the entire period of 9.8%.
While market volatility is never fun to go through, it is a normal part of the investment process and also the reason why equity investors get paid so handsomely over the long term. This is a great time to be doing things like tax loss harvesting in your brokerage accounts as well as Roth conversions while the market is down as well as rebalancing the portfolio to keep it in alignment with your long term plan. Also, if you have cash on the sidelines, this is a great time to buy while the market is at a discount. We are hard at work taking advantage of the volatility to help you create a better outcome over time.
Additionally, we remain optimistic about the US economy and the long-term prospects of the market. Personal net worth is at an all- time high, corporate earnings remain strong and the economy is still doing well. Companies are starting to buy back their own shares which tends to be a driver of growth for the market as well. It is important to remember that a financial plan prepares you for both the good times and for downturns. While a downturn is possible, there’s also a chance the market may not move lower than where it is today. Either way, your plan has been stress tested for times such as these which should give you confidence that you will get through this.
If you have concerns or questions, please feel free to contact our office. We are happy to have a conversation with you.