Volume 91 No. 3 - March 2020
We live in a world of high volatility—politics, weather, supply chains…. The stock market is no different.
How can the Dow Jones Industrial Average reach a record high on February 12, and then enter correction territory less than two weeks later?
The Dow sank more than 1,000 points on Monday, February 24, its then-third-worst point drop in its history. Then, it sank again on February 25, nearly 900 points, to log its worst two-day point loss ever and prompting comparisons to market performance during the 2008 Financial Crisis. The market again posted losses on Wednesday. Then, on Thursday, the Dow closed down 1191 points, its biggest point drop ever. The Dow is now in correction territory.
The S&P 500 has not fared much better. From its record high on February 19, it had dropped 7.6 percent by Tuesday, February 25, losing $1.7 trillion in value in just two days. On Thursday, the S&P 500 dropped another 4.4 percent, entering correction territory, the fastest the index has done after posting a record high since the Great Depression.
How can this be the best of times AND the worst of times?
It’s easy to look at the headlines and see the drivers underlying the volatility we are seeing in the markets right now. The headlines dominating most news sites today revolve around the impacts of COVID-19 and the 2020 election. Just beyond those, worries of an impending recession, overvalued equities, and sliding government bond yields are just below the fold.
Has Volatility Actually Increased?
It depends on how you look at it. According to a volatility study published in The Journal of Wealth Management in 2016, volatility has increased on a day-to-day basis from decades ago. While daily volatility in 1940 ran at an average of less than 0.5 percent, today’s day-to-day volatility exceeds a 1 percent average. So, that heightened volatility you’re sensing in today’s market is actually real.
But, over time, volatility hasn’t really changed that much. That same study found that monthly volatility has only increased marginally since 1940, from just less than 4 percent in 1940 to just over 4 percent today.
Is Volatility Always Bad?
Monthly volatilities of 3 to 4 percent have been with us for a long time—since the 1940s. Of course, over time, the raw numbers behind those swings have grown. In the year 2000, when the average daily closing price of the Dow was just over 10,000, a 1,000-point drop would have meant a 10 percent decline. At today’s DJIA levels, that 1,000-point drop is closer to 3.5 percent of the index’s value.
Volatility is a natural element of a functioning market and encourages the behavior that most long-term buy-and-hold investors want.
Research shows that long-term buy-and-hold investors are rewarded for sticking with an investment selection and strategy over a period of time. Volatility also helps rein in the ‘irrational exuberance’ that sometimes builds among investors during a period of continued strong performance of the markets. To keep investors from pushing stock prices beyond what the underlying fundamentals support, volatility helps reset prices so that they reflect the strengths and performance of the issuing company, and not speculation about markets, news events, and fears. In this way, volatility helps support the markets’ long-term health.
Living with Volatility
Volatility is necessary to have returns. Absolute security and returns are inconsistent.
We’ve been here before … and have recovered. The biggest percentage-point drop in Dow Jones history remains 1987’s Black Monday crash, which wiped out over 22 percent of the market’s value in a single day. The second- and third-largest drops, each approximately 12 percent, both date from the coming of the Great Depression in 1929. Where do the drops from Monday and Thursday rank in this list?
It’s important to note that Monday’s point-drop equates to a 3.6 percent one-day loss and Thursday’s point-drop represented a 4.4 percent loss. Neither of these days ranks anywhere close to the top 20 largest percentage drops in the market’s history.
Volatility since 2015 more or less mimics the same volatility patterns we have seen over the last 30 years—and, since the 1980s, the value of the S&P 500 has increased more than eight-fold. While volatility in absolute terms and day-to-day may seem higher due to the faster reactions enabled by automated trading, longer-term month-to-month volatility is consistent with what we’ve seen for years.
What to Do?
Market corrections happen, and often. Since World War II, there have been 26 corrections, some for unusual reasons, like this downturn caused by the uncertainties surrounding COVID-19. In those seventy-five or so years since World War II, the average correction has set the market back 13.7 percent. Recoveries have averaged about four months. What’s different about now is that this is the S&P 500’s fastest 10 percent decline from an all-time high since 1933. A lot of things can be read into this, however, the main takeaway is that, like recent market volatility trends, the market is producing more volatility in shorter bursts now.
This time, the cause of that volatility is the COVID-19 coronavirus and what it means for society and the economy. While the virus’ next and lasting effects remain to be seen, we should remember that the best way to beat short-term volatility is to let yourself invest for the long-term in a well-reasoned buy-and-hold strategy. If you’re willing to accept some on-paper losses from one day to the next, you may find that over time, this volatility makes our markets stronger, enforces market dynamics, and allows new investors to enter the market, thereby increasing its value over time. In short, there will be storms, but the sun has always returned.
The Waiting Game
It’s hard to wait. It feels like doing nothing. But, it’s also standing your ground. In a buy-and-hold strategy, volatility that brings downturns can test our resolve, especially when it is tied to something as emotional and fear-provoking as a possible pandemic.
At Investment Counsel, we are here to help. Call us to discuss your portfolio, your concerns, and to help you analyze your holdings and strategy. While day-to-day, you may need to weather some storms, diversified, long-term investment mindsets have been shown in the past to produce better results over time.
Since the middle of last year, Investment Counsel has approached the market cautiously, pared back on positions, and reviewed our stock selections to make sure we are prepared for today’s market vulnerabilities. Right now, we’re waiting for stabilization, which we anticipate coming once the COVID-19 scare has passed and the 2020 presidential election has more clarity. At that time, we will adjust our portfolios and redeploy cash.
The best things often come to those who can show patience and wait. Even when it’s hard to do so.
Investment Counsel Inc. is a registered investment adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.