Feb 25, 2022 Market Update: February 25, 2022
It has been a rough start to the year for risk assets with the S&P 500 off 11%+ and U.S. growth stocks down even more. Both the Fed’s hawkish pivot and the Russia/Ukraine conflict have weighed on risk assets.
We haven’t seen a 10% correction in the S&P 500 since March 2020, and we only had a single 5% pullback last year. The average year sees nearly three separate 5% corrections, putting in perspective just how rare last year was with only one and why greater volatility this year would be quite normal. The S&P 500 has had about one 10% correction per year (see our recent blog here for more detailed analysis).
This type of market volatility can make investors worry and be a catalyst for ill-timed trading decisions. Investors have also had to navigate extreme style rotation. Many growth stocks that benefited from COVID have seen greater than 50% corrections in the last three months while value-oriented stocks have held up relatively well so far. We were trimming our growth holdings last year and adding to value and lower volatility equities.
While a 11%+ pullback in equity prices is never enjoyable, we don’t believe recent market weakness is indicative of a certain recession. The COVID-19 case count has dropped dramatically, corporate revenues and earnings both continue to grow meaningfully, and the U.S. consumer is benefitting from rising wages, ample savings, and home price appreciation. Of course, there are always risks including continued contraction in valuations, tighter financial conditions and inflation pressures to name a few.
The economic backdrop is important because the average market drawdown was shorter in duration and less severe when there wasn’t a recession versus when there was one (see graph below) (1). On balance, we think the rewards outweigh the risks for equities and we are looking to take advantage of the volatility and add to stock positions.
Time in the market matters, not timing the market
No one can accurately predict short-term market moves, and investors who sit on the sidelines risk losing out on periods of meaningful price appreciation that follow downturns.
Even missing out on just a few trading days can take a toll. For example, a hypothetical investment of $1,000 in the S&P 500 made in 2012 would have grown to more than $3,790 by the end of 2021. But if an investor missed just the 10 best trading days during that period, he or she would have ended up with 44% less (2).
Diversification matters
A diversified portfolio doesn’t guarantee profits or assure that investments won’t decrease in value, but it does help lower risk. By spreading investments across various asset classes, investors can buffer the effects of volatility on their portfolios. As a result, overall returns won’t reach the highest highs of any single investment — but they won’t hit the lowest lows either.
This correction is hitting expensively valued growth stocks particularly hard (see purple line below). Value-oriented U.S. stocks (blue line) have fared much better than growth areas of the market and non-U.S. stocks (orange and red lines) have performed better than the S&P 500 Index (green line). While bonds (yellow line) haven’t had positive returns in this drawdown like they have in many past drawdowns, they have had better relative returns than the S&P 500 Index (3).
Zooming Out
History has shown the longer the period, the greater the chances of a positive outcome. For example, over the past 71 years, 99% of 10-year periods have had positive returns for stock investors (Green bar below) (4).
We can also look at recent history to provide additional context. For example, the CRSP U.S. Total Market Index returned 16.3% per year over the last 10 years, a period in which there were 14 drawdowns of at least 5% (four of those were drawdowns greater than 10%) (5).
The bottom line?
Downturns and volatility are part of investing. As investors, we can’t control markets, but we can control our risk levels and how we react.
We realize it’s easy to say volatility and market dips work themselves out over time, but we know it’s much harder to live through. It can be challenging to watch your portfolio decrease, no matter how much of a buying opportunity it may present.
Please reach out to your advisor if you would like to review your accounts.
(1) Table from Ben Carlson
(2) Capital Group
(3) Koyfin
(4) JPMorgan Guide to the Markets. Based on calendar year returns. Stocks represented by the S&P 500.
(5) Avantis Investors, Monthly Field Guide, January 2022
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