Market Volatility: Three Things to Remember in Scary Times

History has shown the value of staying invested during prior episodes of market turmoil.

In Brief

• Investors have experienced renewed market volatility following reports of the spread of the Covid-19 coronavirus to a number of countries.
• But equity market volatility has been a fairly common occurrence over the years. Meanwhile, the U.S. stock market (as represented by the S&P 500 Index) has weathered a number of negative events in the past four decades and posted double-digit annual returns.
• We would also point out that previous episodes of panic-driven selling of equities would have caused investors to miss out on the market’s strongest days, lessening returns over the long term.

Global financial markets have experienced volatility in the past several days given the uncertainty of the impact of the global spread of the Covid-19 coronavirus. (Lord Abbett director of strategic asset allocation Giulio Martini has offered commentary about how the U.S. and other global economies had been strengthening ahead of the outbreak, along with an update on the economic and monetary policy implications for China and other nations.) We all know that markets do not like uncertainty. But while we don’t know when, or how, the situation might change for the better, we do know some important things about how the market has responded to prior episodes of volatility. We’ll share three of them here.

1.  Market volatility is nothing new.

Amid the scary headlines emanating from news outlets, it is important to remember that market volatility is normal. In fact, pullbacks of 10% are normal, and typically happen every year or two.

Take a look at Chart 1. Market data dating back to 1980 show there is typically a pullback each year (on average about a 13% drawdown). But most years the market has ended up positive, with an average return of 13%.

Chart 1. Does a Significant Drawdown Automatically Mean Negative Returns for a Given Year? No
S&P 500 annual total returns versus maximum total decline, as of December 31, 2019

Source: Morningstar.
Note: The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is not a reliable indicator or guarantee of future results.

2.  The market has been resilient following prior crises.

While the coronavirus outbreak is indeed concerning, with the human and economic toll difficult to predict, we think it’s worth noting that the market has weathered a number of other negative events in the past several decades. Just look at this (partial) list of market shocks since 1980:

Source: Bloomberg and Lord Abbett.

3.  It’s not “timing the market,” it’s time in the market.

Periods of volatility can be alarming for investors, some of whom might flee the markets in an attempt to preserve capital, and then later try to time a reentry at the most opportune moment to rebuild wealth. Such a strategy is called “market timing.” For it to be successful, it would require an ability not only to forecast the future correctly but also to do so consistently over time—because, presumably, an investor would want to time future exits and entries as well.

Absent these abilities, we believe there’s a more prudent approach. 

Why? Investors who try to time the market around volatility risk missing out on the potential long-term returns of the market. Chart 2 illustrates the growth of $10,000 in the S&P 500 for investors who missed the 10, 20, and 30 best days of market performance in the past 25 years. 

Chart 2. This Is What Happens to Your Portfolio When You Miss the Market’s Best Days
S&P 500 annualized returns and growth of $10,000 for the period January 1, 1994–December 31, 2019

Source: Standard & Poor’s and Lord Abbett. Returns are measured based on the S&P 500^® Index. The “best” days to be invested are defined as those on which the S&P 500 Index delivered its highest returns for the given periods based on historical data. Annualized return and total return assumes the reinvestment of all dividends and/or capital gains.  Past performance is not a reliable indicator or a guarantee of future results.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results.  Indexes are unmanaged, do not reflect deduction of fees and expenses and are not available for direct investment.

Some Final Thoughts

Here are a few other concepts we think investors should keep in mind during periods of market tumult:

Stay diversified: While we have emphasized equities here, we believe that investors should make a habit of checking with their financial advisors to make sure their portfolios are properly diversified (for example, finding a strategic balance among stocks, bonds, credit, and short-term/liquid assets).

Stay focused: Volatility can be difficult to live through—no one knows how long it may persist. But volatility often can create opportunity. As of this writing (February 27) U.S. stocks were down 10% from recent highs while U.S. high yield credit spreads were wider by about 100 basis points (bps) from their lows reached in mid-January. As we have noted many times, such short-term market dislocations may create attractive entry points in key asset classes, and allow for active managers potentially to take advantage of opportunities.

Stay calm: News headlines may be alarming, but long-term investors have weathered scary times before. Rather than reacting to short-term market moves, it may be more important to make sure your asset allocation is appropriate for your time horizon and risk tolerance.

As always, Market View will keep an eye on the current situation and will offer updates as needed.