Putting recent market volatility into perspective

A version of this article was originally published on February 7, 2022.

It’s been a bumpy ride for investors so far in 2022.

Morningstar’s US market index is down almost 19% year-to-date through May 20, 2022, with previously high-flying areas like growth stocks, technology companies and impulse names, have been particularly affected. More than half of the underlying stocks in Morningstar’s US Market Index, including widely used names like Tesla (TSLA)amazon.com (AMZN)Metaplatforms (FULL BOARD) (formerly Facebook) and Netflix (NFLX)— are now down 30% or more from their 52-week highs. While broader market benchmarks have been a bit more resilient, growth stocks have officially dipped into correction territory: Morningstar US Small Growth, US Mid Growth and US Large Growth indices fell at least 30% in so far this year until May 20.

Although the year has gotten off to a more volatile start than usual, recent market jitters are not entirely unheard of. In this article, I’ll discuss current market volatility in relation to the above norms and suggest some ways for investors to deal with it.

How bad is the current market?

As the graph below shows, volatility has been trending upwards. The CBOE VIX Index, which measures market expectations of stock market volatility based on index options for the S&P 500, has trended higher after a relatively quiet year in 2021. Markets have been shaken for a few different things: ongoing concerns about new strains of the coronavirus, political instability in Eastern Europe, a sudden resurgence in inflation, and fears that rising interest rates could increase the odds of a recession. As a result, the VIX has recently spiked into the low 30s, compared to a long-term average of around 19.3.

Real volatility has also increased. After an unusually quiet year for most of 2021, the standard deviation of Morningstar’s US Market Index has also started trending higher. The standard deviation stood at 16.10% for the 12-month period ending April 30, 2022, compared to 10.77% for calendar year 2021.

A line chart of the rising volatility of Morningstar's US market index in 2022.

This volatility has also translated into more frequent losses. Since the market started to get more nervous in November 2021, about half of all trading days have been closed at a loss in the market. The number of trading days with losses of 2% or more has also increased significantly.

Everything is relative

However, when viewed in the context of longer-term historical averages, recent market performance has not been that out of the ordinary. As the table below illustrates, market losses are quite common. Around 45% of trading days end with negative returns. Losses are less frequent with longer periods, but are still relatively common. Historically, approximately 42% of weekly trading periods ended in negative returns, and around a third of all monthly trading periods ended in the red. Over longer periods, annual returns have been negative about a quarter of the time.

A table of the frequency of daily, weekly, and monthly negative returns since 1992 and annually since 1926.

Recent market volatility hasn’t been too far out of the usual range. Since November 2021, there have been 73 trading days (out of 203) with negative returns, but only 11 of those days have closed with losses greater than 2%. Volatility probably looks higher in part because we have seen some more dramatic intraday swings; furthermore, growth stocks have suffered much more frequent and severe losses.

Some investors may also be alarmed by the recent market turmoil simply because we haven’t seen much in the recent past. The new coronavirus-fueled bear market in early 2020 was unusually fast and severe, but also surprisingly short-lived. After falling about 34% from February 19 to March 23, the stock soared to make a full recovery in August.

After the 2020 rally, 2021 turned out to be another subdued year for equity investors. Market volatility was well below average, approximately 20% standard deviation below the long-term historical average for the year. With a few exceptions (such as the tech, media, and telecoms correction that began in 2000, the global financial crisis in 2008, and the uncertainty brought on by the pandemic in early 2020), market volatility was also generally below average during trading. previous three decades.

Based on past history, periodic market downturns are completely normal and to be expected. Over longer periods of time, the market tends to self-correct; certain areas can become foamy and reach bubble status, and overall market valuations can overshoot the mark, but periodic recessions are one way to correct the excess. Looking ahead to 2022, the broader market was trading at a 5% premium to the aggregate fair value estimated by Morningstar equity analysts. After the recent drop, valuations now look more reasonable.

Why the road ahead could still be bumpy

While valuation risk seems like less of an issue, there’s no guarantee the market turmoil will die down anytime soon. It is a cliché to say that we are living in unprecedented times, but we are really in a period of flux and regime change. The previous 30 years (1991–2020) were generally marked by declining interest rates and benign inflation, creating a favorable environment for both stocks and bonds. But both measures are now changing course. After being well below average for several years, inflation has recently held at an annualized rate of 8.3%, its highest level in the last 40 years. The Federal Reserve has signaled that it expects to continue raising interest rates to keep inflation in check, and 10-year Treasury yields have trended significantly higher in response.

A fundamental regime change for both interest rates and inflation would have far-reaching implications for many asset classes, and it could take a while for the market to adjust to conditions that are very different from those in which most investors have grown. In fact, many long-standing trends have already reversed dramatically in recent months. Market leadership has shifted from growth to value; from technology stocks to energy, raw materials and other sectors; and from momentum names to more moderate factors like value, yield and low volatility. And as stocks and bonds have fallen, the once-strong 60/40 portfolio has recently captured more downside than we’ve been used to in decades.

What it means for your portfolio

It’s also important to note that while market turmoil can be unpleasant, it ultimately doesn’t matter too much for most long-term investors. (Return sequence risk is the exception, because an adverse return sequence puts retirees at risk of depleting their portfolios early in retirement and then missing out on an eventual upturn.) Far greater is the risk of permanent principal loss, or the risk of not meeting your long-term financial goals.

As we’ve covered in previous articles, investors unsettled by market turmoil may want to take a step back to see if their original investment plans still make sense. If you’re approaching retirement, for example, you may need to de-risk your portfolio to mitigate the risk of starting to withdraw during an adverse sequence of returns. If you need to leverage your portfolio for years to come (to pay for larger expenses like a down payment or upcoming college tuition) or are tempted to sell if things take a turn for the worse, those can be legitimate reasons, too. to reconsider your portfolio’s asset mix.

But if your portfolio’s asset mix is ​​still appropriate for your time horizon and risk-taking capacity, it’s best to tune out the noise and avoid making any major changes – stay calm and carry on.

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