Understanding Recent Market Volatility
It’s been a bumpy ride for investors so far in 2022. The Morningstar U.S. Market index was down about 7% for the year to date through Feb. 3, 2022, and previously high-flying areas such as growth stocks, technology companies, and momentum names have been particularly hard-hit. Nearly half of the underlying stocks in the Morningstar U.S. Market Index are now down 20% or more from their 52-week highs. Although the year is off to a more volatile than usual start, the recent market jitters aren’t completely unheard of.
How Bad Is the Current Market? As the chart below shows, volatility has been on an upward trend. The CBOE VIX index, which measures market expectations for equity-market volatility based on index options for the S&P 500, has trended up after a relatively quiet summer. Markets have been shaken by a few different things: ongoing worries about new coronavirus variants, political instability in Eastern Europe, the sudden resurgence of inflation, and fears that rising interest rates could put a damper on future equity valuations. As a result, the VIX has recently spiked into the high 20s, compared with a long-term average of about 19.3.
Actual volatility has also increased. After an unusually quiet year during most of 2021, the standard deviation for the Morningstar U.S. Market Index has also started trending higher. The standard deviation stood at 13.2% for the trailing 12-month period through Jan. 31, 2022, compared with 10.77% for calendar 2021.
This volatility has also translated into more frequent losses. Since the market started getting more jittery in November 2021, about half of all trading days have closed with market losses. The number of trading days with losses of 1% or more has also increased slightly.
It’s All Relative When looked at in the context of longer-term historical averages, though, recent market performance hasn’t been that far outside the norm. As the table below illustrates, market losses are actually pretty common. About 45% of trading days finish with negative returns. Losses are less frequent with longer periods, but still relatively common. About 42% of weekly trading periods have historically ended with negative returns, and about a third of all monthly trading periods have finished up in the red. Over longer periods, annual returns have been negative about one fourth of the time.
Note: Daily, weekly, and monthly figures are based on total returns for the Morningstar U.S. Market Index starting in 1992. Annual figures are based on total returns for the IA SBBI Large Stock Index starting in 1926.
Recent market volatility hasn’t been too far outside the usual range. Since November 2021, there have been 34 trading days with negative returns, but only two of those days have closed with losses greater than 2%. Volatility probably seems higher partly because we’ve experienced some more-dramatic intraday swings; in addition, growth stocks have suffered much more frequent and severe losses.
Recent volatility can seem alarming simply because we haven’t seen much of it in the recent past. The coronavirus-driven bear market in early 2020 was unusually swift and severe but also surprisingly short-lived. After the 2020 rebound, 2021 proved to be another temperate year for equity investors. Market volatility was well below average, with a standard deviation about 20% below the long-term historical average for the year. With a few exceptions, market volatility was also generally below average over the three previous decades. Based on past history, periodic market downturns are entirely normal and to be expected.
What does the future hold? While valuation risk looks like less of an issue, there’s no guarantee that market turmoil will settle down in the short term. We are living in unprecedented times 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 reversing course. After running well below average for several years, inflation has recently been running at a 7% annualized rate, its highest level in the past 40 years. The Federal Reserve has signaled that it expects to begin raising interest rates later this year to keep inflation under control, and yields on the 10-year Treasury have already edged up in response.
How Should You Respond? It’s important to remember that, while market turmoil can be unpleasant, it ultimately doesn’t matter too much if your portfolio is built properly and you use a long term investment approach. At Equivest, these are two of the primary principles we use with our clients when are developing their investment strategy. The main exception to this approach is if you are considering retiring soon or are in the early stages of retirement where Sequence of returns risk can have a significant negative impact on your retirement plan.
If you are unsettled by market turbulence, or you're not sure if your investment strategy is built to handle market volatility, that isn't likely to go away anytime soon, now is an excellent time to speak with a professional and revisit your approach. Schedule a call with us today. If you’re approaching retirement for example, you might want to take steps to mitigate the risk of having to make withdrawals during a down market. Similarly, if you’re tempted to sell if the market gets worse, you should reconsider your portfolio’s asset mix, but if your portfolio’s asset mix is still a good fit, it’s best to tune out the noise and avoid making any major changes: Keep calm and stay invested!
Not sure if your portfolio's asset mix is good fit? We can help! Schedule a call with us today to learn how we can help you ensure your portfolio is built properly to handle market volatility and achieve your goals.
Mike Bink, AAMS®, CCFS®
Mike is the founder & president of Equivest Financial Advisors. He is a husband, father of 3, and a fiduciary advisor who is passionate about helping his clients take control of their retirement and reach their financial goals. Learn more about Mike.