At the time of this writing the broad US stock market (S&P500) has declined 20% from its most recent high, marking an official market “bear market”. In Canada the broad index has declined 10.5%. The US market, as measured against the S&P500, is down to a level first reached in November 2019, while the narrower Dow Jones Industrial Average is at a level first reached in January 2018. Of course, the question we all ask is “where does it go from here?”.
What do we know about past cycles?
There have been approximately 24 corrections in the S&P500 since WWII. In that time period the market has had negative 10% returns in basically every calendar year. It has had a negative 15% return about every 18 months and a negative 20% return about every three years. So, this pullback is not uncommon, even though it feels awful when it is happening.
As we know, the main causes of this downturn have been threefold; first, we have supply chain issues that are present which has led to a higher-than-normal inflation rate. Secondly, we have a war that has occurred between Russia and Ukraine that has increased risk levels in those regions and the broader globe. And thirdly, we are still dealing with a global pandemic and the fallout from it.
Supply chain issues will be corrected. If demand stays strong the suppliers of the world will work hard to fill any gap. That is in their financial best interest- to produce things to sell that there is a demand for. As such this issue will go away over time. Of the three issues identified it is the one of least concern. Central banks around the world have been increasing interest rates to slow down spending that will result in a decline in inflation rates.
The Russia / Ukraine conflict is probably the most troubling. There are so many unknowns when it comes to war, however wars do end. When war ends there is a rebuilding period that requires resources that fuels economic growth. This is not written to diminish the current impact on the citizens of Ukraine. We are hopeful that this unnecessary conflict comes to an end soon and our hearts are with those most impacted.
The third issue is the global pandemic, and the impact on the global economy. “This has many economic implications,” says Wharton management professor Mauro Guillen. “It has implications not just for China but for the entire world. The world depends on Chinese growth,” he says, citing both the country’s supply-chain role and consumer buying power. Still, he notes: “It is unclear how much impact in the end this is going to have.”
Prior to the selloff in March of 2020 due to the global lock down from COVID, the last correction we experienced ended in December 2018. The S&P500 had declined almost 20% from its previous high level. While the catalyst for these corrections varies from time to time, the net result is very similar for each occasion – namely a broad market decline across most sectors and industries. Typically, in times like this we also see a flight to safety, resulting in gains for other asset classes such as bonds and gold. However, in a period of rising interest rates bond prices have come down leading many to question if they should own bonds at this time. The answer to that question is yes. With rising interest rates come rising income from bonds that are issued now. Bonds that are already trading in the market mature at par, meaning that if you hold those bonds to maturity, you get the maturity value. With continued volatility in the stock market, it is likely we will see a pattern of flight to safety occur. This is when investors sell their stocks because of fear and buy bonds for security. This pattern has occurred in every major market correction in history, and it is likely that this is exactly what will occur this time.
At this point we will not be able to predict all the effects from the three issues identified: Supply Chain issues, Russia/ Ukraine conflict, and the lingering effects of the global pandemic. In this, as in previous periods of market disruption, we continue to focus on the things we can control – namely our asset allocation and diversification. Balanced portfolios that hold bonds as well as stocks will see less dramatic drawdowns due to the cushioning effect of bonds on the overall volatility. Since timing our way into or out of any specific asset class can be difficult if not impossible to perfectly execute, periodic rebalancing can help to keep the asset allocation in line with your long-term strategy and allow us to “buy low and sell high” without having to make market timing decisions.
What do we know about past cycles during the recovery phase?
While markets seem pessimistic during times of pullback they often recover quickly. On average the S&P500 has posted positive 55% returns after a market correction. The average duration of a bear market being only fourteen months while the average duration of the subsequent bull market lasting more than seventy-one months.
Many investors are feeling angst, maybe even fear. And that is perfectly normal and ok to have and feel those emotions. It is not that we have those feelings it is what we do with them. The answer of what to do with those feelings is this…stay the course. Don’t make major changes to your asset allocation or portfolio simply because the market is down right now. Market volatility is inevitable, and it can be unnerving when it occurs.
However, downturns tend to be temporary and having a well-diversified portfolio that is aligned with your true tolerance for risk should help to ease our concerns as this current situation plays out.
Sincerely,
Colin Andrews, MBA, CIM, FCSI