The stock market closed last Friday over 9% below its recent peak and is now negative for the year. Interest rates have retreated, with the 10-year yield falling to 3.08%. Many sectors are in or near correction territory, including Financials, Industrials, Materials, and Communication Services. The VIX, often referred to as the market’s “fear gauge,” jumped from 11 earlier this month to 24.
For long-term investors, the best way to manage volatility hasn’t changed: by staying balanced and focusing on long-term goals. This advice is offered so often it most certainly sounds cliché. However, the core of these investment principles is an understanding of what we as investors can and can’t control. Market gyrations are unavoidable, and at worst many investors have gone either mad or insolvent attempting to time these moves. At best, investors waste time and effort focusing on day-to-day market noise.
What we can control are our own investment behaviors. Investing in stocks can be risky business, which is why we include bonds, international stocks, real estate and other uncorrelated assets in portfolios. Over the long run, markets tend to trend upwards if the economy is healthy. Markets are also either difficult or impossible to time – trying to do so means we’ll miss as many good days as bad. Ultimately, setting an appropriate portfolio and sticking to it is still the best way to weather choppy markets.
Many factors have led to recent volatility, resulting in a 9% pullback from recent peaks. Still, the worst market pullbacks of this year were above 10%, experienced in February and again in April. How does this compare to history?
Unless the market moves up in a straight line, every year will experience some sort of market pullback. The average pullback since World War II is 13.5%, which includes spectacular bull markets and disastrous bear markets. Some years experience slight pullbacks, such as 2017 and 1995, which saw only 3% intra-year declines. Most years see large intra-year pullbacks even though they end the year positive. For instance, 1998 experienced a 19% intra-year decline, close to bear market territory, before ending the year +27%.
These pullbacks are a test of investor discipline. They tempt investors to give up on long-term investing. Occasionally, this may appear justified with the benefit of hindsight. However, in the vast majority of cases, market pullbacks are par for the course. Volatility is the norm and can only be managed by investing over long time horizons and via diversification, not by trading in and out of the market.
Recent global market performance is a reversal of 2017
2017 was an exceptional year for global markets. The chart above shows the effect of the global coordinated growth that propelled all markets upward. Strong global earnings and policies such as tax reform resulted in unprecedented levels of investor enthusiasm through the early part of this year.
Most of 2018 has looked much different. Markets have diverged due to a variety of issues, including trade wars, Fed tightening, slower international growth, elections, and more. Focusing only on these two years would mistakenly suggest that the ride is over – that the bull run of 2017 was a “normal” market, and that we’ve now missed it. This is why it’s important to take a longer term perspective.
Volatility is normal across global market cycles
Taking a longer 15-year view, covering multiple cycles, suggests there’s nothing abnormal about volatility. While the U.S. and other developed international markets tend to rise over time, there is always significant choppiness along the way.
Emerging markets, in particular, are extremely volatile. Indeed, investing at market peaks for fear of missing out can be problematic. Thus, in these markets, it’s important to have a strategy that focuses on valuations and attractiveness within the market – and not just whether recent returns have been positive.
Despite this volatility, over long periods of time, all markets tend to rise. At the very least, the different behavior of these markets helps to create balance in a diversified portfolio, even if each individual component is volatile.