It’s no secret that markets have been gyrating over the last few weeks as investors have focused on inflation. In our opinion, volatility will continue for a while until it becomes clear that we have seen some peak inflation – obviously, the timing for that is up for debate – and the current CPI print likely muddied the water.
I know that we’ve continued to have volatility for the last several weeks, but let’s focus on last week’s move as it exemplifies our environment, precisely the truly historical movements in the equity market we witnessed last week. The following data doesn’t even include Monday’s -3% move. Stock prices rose 3% last Wednesday after the market read Powell’s comments at the press conference as very dovish, i.e., “we are not considering a 75bps hike”, only to drop 3.6% the following day as unexpectedly high unit labor costs rekindled expectations of a hawkish Fed. Only seven other times since 1970 has the S&P 500 swung more over two days – and this isn’t even taking into consideration the move from Monday.
As many of you could imagine – we saw a few of those gyrations during the covid-induced correction. Three of the eight times occurred during that period. Another three periods came during the month following the Lehman collapse in 2008. The final episode was in October 1987; we are in rarified air.
Furthermore, U.S. Treasury Yields also moved a bunch – but from a comparative standpoint, it was much less volatile than equities. For example, the U.S. 10YR Treasury fell 11bps on Wednesday, only to bounce 10bps the next day. Back-and-forth moves like this happen more often.
But, when you combine these two events, the last few days were an unprecedented event. It was the first time since 1970 that both equities and treasuries rose so much one day and dropped so much the following day. During inflationary periods stocks and bonds tend to be more correlated.
As many of you have heard us say, we believe that the “Fed Put” is gone for the foreseeable future. Last year, the Fed took a bet on estimating where inflation would be – they were wrong. Both politically and from a trust standpoint, The Fed can no longer do that. Thus, the Fed will likely continue to raise rates – tightening policy – until its preferred measure of inflation, the Core PCE, is closer to its longer-term target. The Fed’s credibility is dependent on its ability to control the problem that they are partially responsible for creating. As we’ve said for quite some time, this will likely continue to affect valuations at the market level in the most immediate term.
If there is a continued sell-off in stocks, earnings seem like the apparent catalyst. Many sell-side analysts haven’t lowered EPS estimates – since the beginning of the year, 2022 EPS expectations have increased by almost 7%. One could wonder if current valuations are already pricing in a less rosy slowing EPS expectation.
The market is in unchartered waters right now – this is no secret. We believe that volatility is here to stay until the market believes that inflation has peaked. Volatility tends to be associated with downturns, but the market can also be volatile to the upside. We are prepared for volatility if it goes in either direction – both at the fund and asset allocation levels.
The Failure to Stay Invested:
We know that we beat a dead drum here, but it’s always a good reminder to go over the importance of staying in the market.
It Pays to Remain Invested – There may be many reasons for not staying invested. Still, we believe it is typically an individual’s fear of a significant drawdown or an attempt to time the market. Both can be detrimental to portfolio returns and increase longevity risk within portfolios. To prove this – look at the chart below-depicting returns if we exclude some of the best days in the market:
Remember to Expand Your Time Horizon – No one ever knows what the market will do – especially daily – we know that volatility tends to breed more volatility – whether it’s up or down. Investors also tend to focus too much on the short-term “noise” in the market. There is usually a great deal of day-to-day variability, with different economic, geopolitical, and company-specific news constantly moving markets. We believe the best method for loss avoidance is to expand your time horizon. Let’s take another look at the numbers:
These Max Intra-Year Drawdowns are Normal – The S&P 500 has returned 10% annualized since 1928 with an average intra-year drawdown of -16.3% (at -16.8% this year). There’s no upside without a downside, no reward without risk. Maintain the plan.
We believe the numbers are clear, but these are complex behavioral and financial decisions – volatility in your hard-earned assets is emotional. Stay tuned for our next important post, Thinking Well.
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward-looking statements cannot be guaranteed.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results indicate future investment returns. All investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to consult with investment & tax professionals before implementing any investment strategy. Investing involves risk. Principal loss is possible.
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 11.2 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 4.6 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. This includes Treasuries, government-related and corporate securities, mortgage-backed securities, asset-backed securities, and collateralized mortgage-backed securities.
The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends.
No representation is being made that any model or model mix will achieve results similar to that shown. There is no assurance that a model that produces attractive hypothetical results on a historical basis will work effectively on a prospective basis.
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