Written by: Meera Pandit
After a peaceful 2021, volatility has picked up meaningfully in 2022, with corrections across major indices. The S&P 500 is down -18% from its January 3rd peak, while a brutal sell-off in tech has sent the NASDAQ down -29% from its November 19th high. Compounding the pain in equity markets is the nearly -10% drop in U.S. aggregate bonds.
What’s driving this market volatility? The war in Ukraine is causing surging commodity prices, COVID lockdowns in China are exacerbating strained supply chains, and 40-year-high inflation has prompted the Fed to aggressively tighten monetary policy. Together these dynamics are also creating uncertainty about future growth. However, it is important to highlight that the U.S. consumer has been resilient, the labor market is strong, profits are still growing, and now valuations have reset.
Given that, how do investors navigate this market volatility? As we highlight in "Investing with Composure", here are several key principles to bear in mind:
- Volatility is normal – A booming consumer, robust profits, and ample fiscal and monetary accommodation drove a 27% gain in the S&P 500 in 2021 with only a -5% drawdown during the year. Yet the S&P 500 falls -14% on average each year, so 2021 was far from normal while this year is in line with historical drawdowns. Ultimately, annual returns have been positive in 32 out of the last 42 years, underscoring the need for patience.
- Diversification supports portfolios through market downturns. If you had invested in the equity market at its October 2007 peak, it would have taken you until March 2012 to recover your initial investment. However, if you had invested in a 60/40 stock/bond portfolio instead, your portfolio would have recovered in October 2010 – a year and a half earlier. Diversification captures returns on the upside and protects on the downside to deliver better risk-adjusted returns.
- It’s about time in the markets… Being invested in the equity market for any one calendar year since 1950 could have yielded a 47% return or a -39% return. However, over longer time horizons the range of outcomes is compressed significantly and overwhelmingly skews positive, particularly if diversified with bond exposure. A 50/50 diversified stock/bond portfolio did not experience a period of negative returns over the rolling 5, 10, or 20-year calendar periods since 1950.
- …not timing the markets. Investors are often tempted get out when markets get choppy. However, if an investor were to miss the 10 best days in the market rather than staying fully invested, they would have cut their return in half from 9.5% to 5.3% annualized over the last 20 years. What is the chance of missing the 10 best days? Seven of the 10 best days occurred within two weeks of the 10 worst days, often immediately following the worst days. Exiting on a bad day means potentially missing the rebound.
- Stay invested when you feel the worst – Sentiment is not a great guide for investor behavior. Looking at the peaks and troughs of consumer sentiment since 1970, average one-year equity returns following peaks in consumer sentiment were 4.1%, but average returns following the bottoms in sentiment were 24.9%.
One more crucial point: through multiple wars, recessions, pandemics, and crises, the S&P 500 has never failed to regain a prior peak— and then surpass it. The best strategy during volatile times is to maintain composure and stick to your investment plan.
S&P 500 intra-year declines vs. calendar year returns
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. Intra-year drops refers to the largest market drops from a peak to a trough during the year. For illustrative purposes only. Returns shown are calendar year returns from 1980 to 2021, over which time period the average annual return was 9.4%. Guide to the Markets – U.S. Data are as of May 10, 2022.