We’ve been thinking about the recent ups and downs of the stock and bond markets. The past three calendar years (Covid shutdown included) have been very good to stock investors. 2021 was a steady upward climb for stocks with little disruption, which lulled many folks into complacency. Enter 2022, and it’s a whole different world.
Between the daily droning on by newscasters about runaway inflation, a pending rise in interest rates, supply chain disruptions, and Russia’s saber-rattling, good old-fashioned volatility has returned to markets. We prefer the term “fluctuation.” That it seems to have caught some people off guard isn’t unusual. Conversations have turned to the usual speculation about market dips, corrections, and the prospect of nerve-rattling sell-offs. We’re quick to remind readers we’ve all seen this movie before, and it always ends the same way. But sometimes, a healthy dose of perspective can help.
We all know that stocks are subject to frequent – and sometimes significant – drawdowns. To wit:
- Since 1980, the average annual peak-to-trough drawdown has been 14%. This is not a typo. On average, markets have temporarily swung downward 14% each calendar year.
- During these 42 years, a drawdown of about 30% has occurred roughly once every five years. The last time this happened was in 2020, during the COVID shutdown, when the U.S. stock market saw a 34% decline over three weeks. Does anybody remember this?
- Twice since 1980 (2000-2002 and 2007-2009), the S&P 500 has declined by about half its value.
In the next breath, we note that the S&P 500 came into 1980 with a price value of 108 and left 2021 at 4,766. That’s an average annual compound return of around 12% for those equity investors who had the constitution to look out the window during choppy market swings.
We get it. How can such a stomach-churning roller coaster ride produce such wealth creation? This seems wildly contradictory to folks.
There are three answers:
The first is the healing power of time. Here are the percentages of time the stock market was higher over various holding periods.
In short, time smooths out the risks inherent in owning equities. It is a factually accurate statement that 100% of the time throughout history, when the stock market has gone down, it’s gone back up to new highs. (Read that again – we’ll wait.) Unfortunately, we don’t know how long the recovery will take each time, and that’s where patience comes in.
The second answer is understanding that fluctuation is a feature of the markets, not a bug. Remember, the term “fluctuation” doesn’t mean only down – it means up too. And the price we pay for the advances is enduring the declines. If the declines went away, so would the advances. In short, fluctuations are normal and natural. It doesn’t mean you have to enjoy it – just don’t overreact to it.
The third answer is understanding that daily market fluctuation is directly related to the amount of uncertainty present in everyday happenings. When the world is experiencing a high degree of uncertainty, you’ll see a high degree of daily fluctuation. Markets are trying to sort out current values and future expectations. When things calm down, and the outlook becomes clearer, the fluctuations settle down too. On a brighter note, periods of uncertainty create bargains and buying opportunities, and when the future is crystal clear, those bargains disappear.
Today, we’re in a heightened period of uncertainty for the reasons mentioned in the first paragraph. And markets are doing what they do – trying to sort out the current and long-term outlook for companies and the economy. In the meantime, exercise patience and stay the course. The movie always ends the same way.
The S&P 500 index is an unmanaged group of securities generally considered representative of large U.S. publicly traded companies. The index is owned and compiled by Standard and Poors. Individuals cannot directly invest in unmanaged indices.