Investing and staying invested during periods of volatility can be difficult. Gaining a historical perspective can help expectations and possibly frame current events in a more appropriate context.
Expect short-term volatility from stocks.
Between 1980 and 2021, the S&P 500 closed higher than the day before 54% of the time.
But if we look at an entire year, the percentage improves. Over the same 42-year period, the S&P 500 ended the year higher over 75% of the time. However, it’s usually a bumpy ride.
The average intra-year decline during those years was 14%.
What happens with stocks after a significant crisis?
The markets are constantly moving in response to various factors: news, economic data, expectations, interest rates, earnings, geopolitical events, etc. While the exact circumstances may be the hallmark of one crisis or market downturn won’t precisely mirror the next, the headlines probably have much more in common than you’d think.
In the financial markets, the most extreme volatility is typically driven by bouts of uncertainty. Investors process the data, including bad news, and assets get repriced accordingly. The news media would like us to believe that the sky is always falling.
Headlines vs. returns
Drawdowns typically lasted a few months, and each event saw double-digit returns 12 months after the crisis ended. However, the most extreme examples (the tech bubble and Great Financial Crisis) were significant, multi-year events. Investors should always prepare for any market downturn or personal financial crisis before they find themselves in one.
Source: BlackRock. Data from Morningstar as of 12/31/21. Returns are principal only, not including dividends. U.S. stocks are represented by the S&P 500 index.
Economic recessions vs. the stock market
You may be surprised to learn that in the last 69 years, on average, stocks did worse in the year before a recession began than during the recession itself. The more time passes after the recession, the greater the likelihood of stocks producing positive cumulative returns.
“I should wait to invest because stocks are at all-time highs.”
History doesn’t support the notion that all else equal, putting money in the market when stocks are setting new records is a bad idea. Remember, over time, stocks have gone up three out of every four years.
Source: Dimensional Fund Advisors
“I should wait for the market to recover to invest.”
People love sales. Just not in the stock market. Imagine thinking: I’m ready to buy that car, but the dealer is running a promotion. I’ll wait until I can pay the full price.
Regardless of the entry point, stocks have produced positive returns over time. Investing is about time in the market, not timing the market.
As illustrated in the chart below, average cumulative returns were positive in the one, three, and five years following an investment during a correction, bear market, or 30% drop in the stock market.
Source: Dimensional Fund Advisors
Hindsight is always 20/20
It’s easy to look at charts of past downturns and think I wish I had invested. But in real-time, the middle of a downturn can feel like anything but a buying opportunity.
The first half of this year was the worst-ever start for bonds and the third worst for stocks. Where the market goes from here is anyone’s guess, but historically, bonds are rarely negative, and the best days for stocks usually happen within weeks of the worst days.
Source: BlackRock
Three reasons to stick with diversification.
Diversifying your investments has always been one of the best ways to reduce risk. The chart above illustrates that even diversification at the highest level (stocks and bonds) isn’t working this year. This year is very unusual.
If 2022 ends with losses in both the stock and the bond market, it’ll be only the third time since 1926.
Losses in the bond market are unusual.
The average intra-year drop in bonds has only been 3%, versus 14% for the S&P 500. Further, it’s rare for fixed income (U.S. Aggregate Bond Index) to end the year with losses: it’s only happened four times (about 9%) in the last 46 years.
Source: J.P. Morgan
It’s been a rough year in the market. Still, if you believe in capitalism, human ingenuity, and the cyclical nature of markets, it’s only a matter of time before markets recover.
For illustration purposes only and should not be misconstrued as a recommendation for any specific investment product, strategy, or personal advice. It does not include investment costs or expenses; you cannot invest directly in an index. Past performance is not indicative of future results.