Short-term market volatility can be unnerving, not only because your investments may be dropping in value, but also because the media and everyone around you seems to be speculating about whatever is causing the volatility in the first place. The Trump administration’s on-again off-again tariff policy has been covered extensively in the media and in board rooms over recent months, so it’s no wonder that the stock market has made huge moves up and down in recent weeks. Our series to help investors make smart decisions through this period of volatility has focused on a primary theme that investors can actually benefit from a time like this. It begins with identifying short- and long-term goals and using the financial markets to help investors achieve them. This last installment in our series provides a brief history lesson on the US stock market and context for where we are now.
The chart below from Capital Group provides a superb perspective on bull markets (in blue) and bear markets (in pink). Let’s start with the foundation: market corrections are just as natural to financial markets as periods of recovery and growth. Just as natural. A key takeaway is the magnitude of the bull markets vs the bear markets – bull markets tend to be longer and more substantial, while bear markets are shorter and shallower. This is why people invest - because markets go up way more than they go down.
Bear markets, defined as a 20% downturn in the stock market (which we have not hit yet this year), can be instigated by a variety of influences, but they tend to have one thing in common: surprise. As we have written about many times, the stock market is adept at absorbing and integrating data all day every day. When a significant surprise happens – such as a steep tariff policy that flummoxed those in the US and around the globe – the market reacts by repricing as it assesses the new deluge of information.
While stock market downturns are commonly motivated by a unique crisis, the market’s reaction to the crisis is not unusual, as we mentioned in our most recent article in this series. Let’s break that down to a fairly typical pattern for a stock market correction, often referred to as a “W”-shaped recovery:
- The market gets surprised by a new risk and falls quickly in response.
- The market assesses the actual magnitude of the risk and usually falls further, with investors intentionally getting out of positions and technical trading causing a steep sell-off.
- The selling stops, and investors start to deploy cash into the buying opportunity.
- The market drifts up, as more investors buy into the market and good news begins to hit headlines.
- The reality that we are still in a crisis – and possibly some new information about the crisis – causes investors to get nervous again, and another sell-off ensues.
- If the market returns to the floor that it hit during the first wave of the sell-off, this can be a good sign that the sell-off has reached a bottom, and the market can start to recover.
Now let’s take a look at two bear markets that many of today’s investors experienced.
COVID. The US stock market dropped over 30% from February to March in 2020, as the country realized that COVID was sending us to lockdown, people would lose jobs (20 million in total), and no one could reasonably predict the short-term economic future. The market rebounded quickly, as Congress and the Fed rescued the economy in the form of lowered interest rates, cash to Americans to spend, and support to affected businesses, all wrapped in a $2.3T fiscal package. The US consumer showed enormous power during this time, driving the economy, and boosting the stock market by November of that year to set a new record high. Investors who sold at the bottom missed an enormous rebound and growth period.
Great Financial Crisis. I commonly describe 2008 as a situation where “it’s not that the train came off the track – it’s that the train fell apart on the track, which also fell apart.” If a global pandemic had such a quick recovery, why did 2008 feel so terrible? There were many reasons: layoffs by the hundreds of thousands, major financial firms going completely out of existence nearly overnight, and a simultaneous housing and banking crisis. But there was one more important factor: when the market lost nearly half of its value, it wiped out over ten years of returns. The recession officially ended in June 2009, but the stock market took about four years to fully recover and set a new high. The period from January 2000 - December 2009 is commonly referred to as the “lost decade” because the S&P 500 had annualized returns of -0.95% during that time.
With these two events as a backdrop – 2020 with a quick recovery and 2008 with a protracted recovery – investors are wondering which scenario is more likely due to the uncertainty around the tariff rollout. Meanwhile, financial analysts, market watchers, and economists are remarking on the sway that Trump currently has over the global financial markets and possibly the global economy. While we don’t know the future, we do know that different economic environments can cause various asset classes to perform positively or negatively, which is why maintaining a diversified mix of assets aligned to your goals is important – it gives you more chances to win. It’s also critical to remember that downturns are often followed by periods of substantial outperformance. In fact, if you miss the ten best days in the market over the past 20 years in the S&P 500 index, your returns would have been cut in half. Just like the worst days in the market are a surprise, so too are the best days.
During any period of volatility, it’s tempting to focus on what could go wrong and how bad it can get. We encourage long-term investors to set their vision on the actual long-term, which is probably the horizon for the vast majority of your portfolio. Even if you are taking income from your portfolio now, it is probably only 4-5% per year, leaving 95% of your portfolio invested. Knowing that most of your investments will still be invested 10 or 20 years from now, hopefully this article strengthens your resolve to stay committed to letting the market work for your benefit, matched to your risk level and your financial plan.
This is the final installment of our four-part series to help you focus on how your investment portfolio can continue to serve you through periods of volatility. We reviewed our Five-Step Process to understand your portfolio (purpose, time horizon, expenses, taxes, and risk/reward potential), we examined risk and the role it can play for you, and we provided some ideas about how you can use the current environment of market gyrations to your benefit.
We have received significant feedback about this series, and we appreciate your comments and questions. Our next release will be Risks and Opportunities, our quarterly deep dive on the markets. If you have any topics you’d like us to explain, or if you are new to BFS Advisory Group and want to sign up for our newsletter, please email us at hello@bfsadvisorygroup.com. Our goal is for people to be confident in their decisions about money, and education about the markets is a key component in achieving that goal. As always, we welcome you to share this article with anyone in your life who would benefit from seeing it, whether they are a new or experienced investor.