Market Volatility – Fodder for Financial Fears
Fact: The value of the stock market goes up and down. It’s called “market volatility”. How concerned should you be with a thousand point change in the index? Since your reaction can impact your personal portfolio, it’s most important that you have a good perspective.
Significant price movements in the stock market grabbed headlines and captivated media pundits throughout 2018. The last week of the year the market experienced large price swings—both negative and positive – with the Dow Jones and S&P 500 fluctuating a record number of points. So, what’s the one thing investors should do during these volatile times? Keep it all in perspective.
Who can forget the headlines? “Markets Plummet in Worst Christmas Eve Trading Day Ever” (NBC Chicago, December 24th, 2018). “Stocks Soar as Wall Street Posts Record Day” (CBS New York, December 26th, 2018). When headlines were positive, investors cheered. But when they were negative, many investors suffered anxiety. They began questioning the overall health of the stock market as well as the role of equities in their portfolios.
Don’t get caught up on that emotional roller-coaster ride. It might be easier to maintain a proper perspective by focusing on how these large moves stack up against other volatile days throughout history.
Be Willing to Change your Perceptions
In March 2009, the Dow Jones dropped below 6,500 and the S&P 500 bottomed out at an infamous low of 666. However, the ensuing bull market propelled stocks higher. In the fall of 2018, the Dow Jones and S&P 500 almost reached 27,000 and 3,000, respectively. That’s a staggering return of more than 300 percent in less than a decade!
As stock prices dramatically increased, so too did the size of the price movements on a typical day in the market. If you listen to the media reports it may seem like we’re experiencing an era of unprecedented stock market volatility. Truth is the markets have gone through much worse.
To put the recent price swings in perspective, let’s compare 2018 to 2008. According to 2009 research conducted by famed financial academics Eugene Fama and Kenneth French, when the Great Recession began near the end of 2007, the average daily standard deviation of the stock market was approximately 4 percent. By definition this means that on approximately one-third of the trading days, the market gained or lost more than 4 percent. At that time, the Dow Jones was near 10,000, and a 4 percent move in the market meant the index needed to change 400 points. In 2008, the Dow experienced a percentage move of that size 18 times out of the final 60 trading days of the year!
However, in the fourth quarter of 2018, with the Dow close to 24,000, a 4 percent swing translated to a daily gain or loss of 960 points – not 400 points like in 2008. In the final 60 trading days of 2018, a daily swing of that magnitude occurred only a single time: On December 26th the market more than rebounded from the Christmas Eve decline that sparked headlines.
Stock market prices have risen substantially over the last decade, increasing the absolute size of the numbers today and making it seem like the impact on portfolios is unprecedentedly huge. In reality, the actual market impact on performance was much larger ten years ago.
So, what does that tell you? It’s time for a change in perception. It isn’t the absolute value of the price movements that truly matter; instead, it’s the percentage impact those moves have on your portfolio that ultimately influence the overall performance.
Stick to Your Plan
Despite the market volatility, most economic indicators continue to signal that the overall economy isn’t due for an imminent recession. Unemployment and inflation remain low and in check. Corporate earnings growth, while decreasing, is still well above historic norms.
Furthermore, recent reports indicate consumers spent 5.1 percent more this holiday season compared to last season, reaching a six-year high. Trends in the stock market have recently been negative, but this same sentiment does not seem to be reflected in the underlying economic data.
When compared to historical data, the downward trend we experienced in December is merely a natural and expected part of a market cycle. Unlike what the current financial media suggest, it is not unprecedented. In fact, the high expected long-term returns we associate with stocks come from the very fact that equities carry such risk.
As the saying goes, “there’s no such thing as a free lunch”, and the volatility in stocks is the price you pay for the long-term returns those stocks may deliver.
Jonathan Koop, CFA, is a Portfolio Manager for Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website or email Jonathan.