By the end of last week almost all equity markets finished lower than they started, some significantly so. When this happens, it is natural to want to understand the reason or cause. Has the output of the global economy significantly changed? What about unemployment levels or the earnings and profitability of each listed company? In our view, probably not.
The fact is, there are hundreds of potential reasons why markets might have fallen back. The media like to pick their favourites and run with them. This time these include: a more hawkish US Federal Reserve following strong economic data, Trump’s ongoing trade war with China and higher bond yields making equities look less attractive. All these factors have been known for some time and yet, only now seemed to have impacted markets…
Whilst the above factors may well have had some influence, we prefer our simpler and more straightforward explanation; stocks fell because they rose too much, particularly in the US. The chart below puts into perspective just how much US stocks have outperformed the rest of the world in the last six months.
Looking at the outperformance above it is unsurprising that the US market was initially the biggest casualty as it had the furthest to fall.
On Wednesday, the S&P 500 (US equity index) finished the day down by 3.29%. During these moments it is easy to feel like it’s the end of the bull market. It’s important to note though, that back in February this year, the index fell 4.10% in one day and then a further 3.75% three days later. Most investors had probably already forgotten about these falls by this point in the year. However, like now, at the time many felt it was the end. But, following this the US market climbed back up and, including the latest declines, is still up 3.12% (total return) year to date.
Over the last few years markets have been relatively calm and have exhibited low volatility. So when a sell-off like this happens, it takes investors by surprise. What’s important to remember is that volatility is all part of the investment process and that these events do and will continue to occur. As the below table shows, since the start of this bull market (October 2009) there have been 17 separate one-day declines of greater than 3%, five of which have been larger than 4%. These are not rare occurrences.
Daily S&P Returns 12/10/2009 – 12/10/2018
Naturally, investors would like to avoid these big down days yet some of the biggest one-day gains also occur around the same time. Not only is it impossible to know when these down days might occur but jumping out of the market when they do can mean missing out on the potential recovery in the days that follow.
This can be illustrated looking the best one-day returns and worst one-day returns of S&P 500 Index since the start of the current bull market.
Daily S&P Returns 12/10/2009 – 12/10/2018
As you can see, some of the best one-day returns occur soon after some of the worst. Interestingly, following last week’s multi-day declines the US market closed on Friday up 1.42%.
We cannot say exactly what is going to happen going forward. The recent volatility could just be a step back before markets continue to move higher or we could be in for a more uncomfortable period, only time will tell. Generally however, the world economy is still ticking along nicely. Although financial conditions are becoming tighter, they still remain relatively loose. None of the hard data has really changed in the last week, but the people’s opinion who act upon it has. As we have said in the past, trying to time or second guess what markets (i.e. other investors) might do is a fruitless task. Though these periods are painful in the short-term, investors would do well to remind themselves of their long-term plan and investment time horizon which should always be longer than just a couple of days, weeks or months.
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.