By Bill Hornbarger, Chief Investment Officer
The recent decline in U.S stocks , particularly against the backdrop of surging Covid cases, has left many investors unnerved. Tuesday (Jan. 18), the Dow Jones Industrial Average was down more than 540 points, a number that is sure to capture the attention of anyone who watches the markets.
Veterans of equity investing know that one can always find reasons to worry about market levels. In the current cycle, heightened inflation, a looming change in the monetary policy regime, and the ongoing pandemic have all been cited as reasons to be wary of stocks . The S&P 500 has posted three consecutive years of positive returns, and it has been more than two decades since it was able to post a fourth (1999). Earnings and earnings growth will be key in our opinion to the market going forward. We are currently in fourth-quarter earnings season and earnings are expected to grow approximately 20%. However, we believe the markets will be more selective and look for companies and industries that will be less impacted by the current heightened inflation.
After the strong markets of the last decade and the strong rebound from the 2020 Covid bear market, investors are concerned that another precipitous decline could be right around the corner. In our experience, bear markets are often triggered by events and not just the fact the markets have been strong for an extended period. Recent examples include the Global Financial Crisis (2008-2009) and the forced recession and shutdown of the economy in early 2020 due to the pandemic. While an event could emerge at any time to shake confidence, the environment for stocks is still positive: earnings and the economy are growing, monetary policy, while changing, is still relatively loose, and investors remain interested in stocks with bond yields below the rate of inflation.
A few things that we feel investors should be mindful of in the current environment of increased volatility:
- Corrections happen and are a healthy and normal part of any stock market cycle. Using the definition of 10% for a correction, they happen on average approximately every 18 months and staying invested through them is important.
- Stock declines improve the prospects for forward returns from that point. We firmly believe that price matters and a decline in price and valuation can make for a more attractive entry point.
- Despite the recent decline, the S&P 500 remains less than 5% from its record high.
- Historically, the S&P 500 index has been resilient around the start of Fed hiking cycles. Although the index has returned -6% on average during the three months following the first hike of recent cycles, the weakness has been short-lived as returns average +5% during the six months following the first hike. Moreover, the S&P 500 P/E is typically flat during the 12 months around the first hike. (Source: Goldman Sachs)
- Not all stocks move at the same time or the same direction. So far this year, The S&P 500 Growth index is down slightly more than 5% while its value counterpart is up over 1% YTD.
- Don’t ignore the “base effect.” The higher the indices climb, the larger the point (as opposed to percentage) swings are. On Black Monday (Oct.19, 1987) the DJIA fell 508 points or 22.6%, the worst single day for the U.S. market in history. Tuesday’s (Jan. 18, 2022) 543-point decline by comparison was a percentage loss of 1.5%.
No one likes volatility, but it is a necessary part of stock investing. Stocks have been one of the best performing asset classes over the long-term and to realize those returns, investors must accept volatility and periodic corrections. Actively managing risk through asset allocation and disciplined rebalancing can help investors weather those periods. Another key attribute of successful investing is remaining resistant to panic and euphoria and many investors might be inclined to liquidate a part or all of their stocks in these environments. History has shown a disciplined approach to rebalancing into that volatility has been a winning strategy. With the markets still near record-high levels, and with abundant liquidity, it remains an opportune time to ensure that one’s portfolio is aligned with their individual risk and return objectives and tolerances.