Should I Stay or Should I Go?
At the end of January, we hosted our annual market outlook webinar. Little did we know that it would occur in the midst of one of the most volatile weeks the market has experienced since the depths of the COVID crash. In fact, January proved to be the worst start to the year since 2009 and the worst month for the S&P 500 since March 2020. We entitled our first slide, “Life is A Highway.” When we originally envisioned the exhibit, we planned to point out that 2021 stayed in the fast lane. Despite the S&P 500 experiencing an average yearly drawdown of 14%, in 2021, there was but a minor decline of just 5%. By the time we went “on-air,” our messaging had changed. Market volatility rose considerably, experiencing several large-intraday swings, causing the indices to come close to an “official” market correction, defined by most as a 10% decline. Rather than highlighting 2021’s relatively smooth ride, the chart now served to help reassure clients that volatility was normal and expected.
The pickup in volatility was jarring, which neither the Fed nor geopolitics could fully explain. Perhaps, the more likely rationale is that markets simply needed a reality check. Investors seemingly realized that 2021, which experienced the fastest rate of GDP growth since 1984 along with earnings growth that was nothing short of spectacular, was unlikely to be repeated this year.
After all, they are likely correct. Economists surveyed by the Wall Street Journal expect that GDP will “only” grow by 3.3% in 2022. This remains well above the pre-pandemic trend growth of 2.3%. Similarly, FactSet estimates that 2022 earnings growth will decelerate to 9.2% from greater than 45% in 2021. Again, this remains well above the 10-year average earnings growth rate of 5.0%. After a monumental year, investors are resettling their expectations for just a good year.
Markets may continue to gyrate this year, as they have done before. Our base case is that volatility may cut both ways, with bouts of both bearishness and bullishness taking over for weeks or months at a time. It will be unnerving, but we see no reason to panic. We remind investors of a couple of critical facts.
- While every 20% bear market begins with a 10% correction, most sell-offs do not go that far. Since 1990, the S&P 500 Index experienced 23 market corrections; only seven reached the definition of a bear market. Investors who stuck to their investment plans have more than fully recovered from the drawdown.
Source: Standard & Poors
- Those who exited the market but failed to get back in fast enough generally regret it. Missing just the ten best days in the market between 1990 and 2021 cost investors 2.7% per year. Missing the best 20 days subtracted more than 4.5% per year. These are significant mistakes in a world with expected equity returns closer to 7% than 10%.
Source: Standard & Poors
This historical context may not stop some pundits from inundating the headlines with predictions of doom during periods of stress. We remind readers that there are always reasons to be fearful when investing. Permabears make for good headlines when the market is down. However, as we’ve detailed before, while Pessimism Sells, Optimism Pays. Indeed, in our experience, those with the loudest, most dour voices, foretelling low returns indefinitely, have generally delivered their clients precisely that.
Some clients are probably considering de-risking their portfolios. This sentiment usually emanates from constantly checking their portfolio’s value. Even a five or ten percent decline can be unsettling when translated into dollars. However, the real risk to most clients is not the daily fluctuations of their portfolios. Instead, we believe it’s the longer-term risks of not reaching their return targets or preserving purchasing power. With short-term savings rates still at record lows, eschewing volatility risk may mean taking on substantial inflation risk.
Over the long term, balancing risks may be more effective than trying to sidestep them. Each individual component within a diversified portfolio carries its own vulnerabilities but, through diversification, we seek to balance them.
- Stocks have historically served as the strongest propellant to growth in a portfolio but are also the most sensitive to dislocations.
- Bonds and cash may provide stability during crises but are most exposed to inflation.
- Real assets can offset inflation risk but may underperform in periods of price stability.
- Alternatives seek uncorrelated returns not tied to the direction of equities, bonds, or inflation.
Should investors stay or go in this market? We unequivocally believe that they should stay. Staying invested through volatility has been profitable historically. The long-term returns from staying in the market outweigh the opportunity cost of staying on the sidelines. Moreover, we believe portfolios should look elsewhere to balance their exposure to different types of risk. They should consider other asset classes that complement their US stock and bond exposure, including international stocks, smaller companies, real assets, and alternatives. Rather than avoiding risk, investors should endeavor to diversify it.
Life (and investing) may be a highway, but as any city driver will attest, it’s rare to be able to race through the fast lane without confronting obstacles like traffic, construction, and weather delays. Nevertheless, frequently jumping on and off to side streets is the surest way to delay your arrival.