Increased market volatility is an opportunity to review your personal risk tolerance and asset allocation, while resisting the temptation to time the market.
As analysts and investors, we try to understand what impacts markets and individual stocks on a long-term basis to help our clients achieve their financial objectives. Despite a myriad of daily prognostications about the immediate direction of the market in the next hour, day, week or month, short-term stock market performance is essentially unknowable. The “seers” are even more prevalent during market downturns and when price volatility increases.
Following the market correction in the fourth quarter, the stock market had a sharp recovery in the first four months of 2019. The averages then rolled over in May with the S&P 500 giving back around 6% of its gain since the recent peak on May 1.
There are many reasons given for this recent selloff including:
the lack of a trade deal resulting in the higher tariffs
richer valuations following the sharp rally combined with continuing growth and earnings concerns
antitrust actions threatened against some of the large technology companies
the inverted yield curve (longer term rates are below short term rates)
Federal Reserve policy on interest rates.
That said, market volatility is normal and while downturns are unsettling, history suggests that the market eventually recovers from declines (at times more quickly than others) and typically produces long-term positive returns that beat inflation. According to an analysis by Fidelity, the market has experienced an average drop of 14% per year from the high to the low over the last 35 years, yet produced positive annual returns in 80% of the years during this period. However, your ability to withstand price volatility, no matter how long or short lived, depends on having an asset allocation that is appropriate to and comfortable for your time horizon (more time/more risk/higher returns), understanding your personal risk tolerance (are you lying awake at night worrying about the market?) and having adequate diversification among investments.
The constant media jabbering about the short-term direction of the market begs the question whether market timing is a worthwhile strategy. It is usually the case that market timing results in poor investment decisions--selling when stocks are cheap and buying when they are expensive. Numerous studies have shown that missing the best five or ten best days in the stock market over the long term can result in sharply lower returns than staying fully invested throughout the period. The chart below illustrates this impact using the S&P 500 from an inception date of January 1, 1980.
Whether the current bout of market volatility portends another correction or a bear market is anyone's guess, though the stock market has rallied in June after the Fed chairman hinted at cutting rates if trade disputes cause further economic weakness. Unlike 2017, when world economies were improving synchronously and earnings revisions were generally positive, we now have a synchronized economic slowdown accompanied by negative earnings revisions. A timely resolution to the US/China trade issues would likely be a favorable catalyst for the market in 2019.
However, market declines don't necessarily treat all stocks equally and can create opportunities to buy great companies at attractive valuations as well as upgrade portfolio quality by selling stocks of companies with deteriorating fundamentals in favor of well positioned or better businesses at reasonable prices.
Craig A. Vander Molen, CFA, CPWA ®
Managing Director and Chief Market Strategist