Do you get nervous when the stock market behaves unpredictably and experiences periodic ups and downs? If so you aren’t alone. But what about when the market’s ups and downs are measured in hundreds or thousands of points? That’s a different story altogether.
So far in 2018 we have come to see that the era of relatively calm and steadily increasing markets that we enjoyed over the last couple of years is over. The new normal, it appears, is about volatility, including gigantic moves like the Dow Jones Industrial Average’s 1,000-point drops earlier this year followed rapid, nearly complete recoveries. Case in point: in February the Dow plummeted more than 3,200 points in just two weeks. Shortly thereafter stocks raced back to recover nearly 75% of those losses.
Want more? On February 5th the Dow closed down 1,175 points, its worst point drop in history, and at one point was down over 1,575 points; you guessed it, the largest intraday point drop in history. The previous largest point drop for the Dow was 778 points in September 2008, in the midst of the financial crisis.
In fact, three of the Dow’s biggest daily point drops in its 122-year history, including the aforementioned 1,175-point record fall on February 5th, have occurred in the first quarter of 2018. Further, there have already been over 25 trading days so far this year on which the S&P 500 stock index has closed up or down by more than 1%, compared to less than 10 days in all of 2017. If this pace continues we are in for the most volatile year in the markets since the financial crisis.
If you pay attention to the long-term read on the economy, however, you’ll find that U.S. and overall global economies are actually doing quite nicely. In the U.S., inflation pressures remain relatively low, the labor market remains strong, corporate earnings are rising, and interest rates are rising at a very deliberate rate. All things considered, the stars should be aligned for the US economy and the stock market to keep humming along in 2018. Combined with steady job growth, and let’s not forget the pro-business tax environment, there should be a robust tailwind pushing markets steadily higher.
Unfortunately, it’s not quite that simple. Market volatility is back and it’s back with a vengeance.
On the bright side, volatility is not bad in and of itself – even though it may tend to raise the blood pressure of most investors. Actually, healthy corrections in the market are generally good and provide opportunities to buy good companies with solid fundamentals at more attractive prices. Thus, an ongoing market sell-off may ultimately present a pretty attractive buying opportunity. Need proof, just ask an investor who had the foresight to put money to work in the Spring of 2009. An investment in the S&P 500 in March 2009 would have returned an inflation adjusted 206.8% through March 2018, an annualized return of 13.3%. The return jumps to 15.5% annually when factoring in dividends. Not too shabby.
But for most it can be difficult to stay invested during periods of market stress. It’s human nature to limit losses and preserve what you have. However, reacting to market conditions without rationally evaluating the situation, especially during times of extreme volatility may lead to poor investment decisions at the absolute worst time. So how can you keep all of this volatility in perspective? Well, consider this:
1. Large moves in the market just aren’t what they used to be. A 500-point Dow sell-off today doesn’t pack the same punch as it did 30 years ago. That’s because then the index was at a much lower level so any large drop would generate a more intense impact. For instance, a recent 572-point loss in the Dow only equated to a 2.3% drop, and the massive 1,175-point decline in February, the largest intraday point drop in history, only represented a 4.6% loss. Contrast that with the Dow’s infamous Black Monday decline of 508 points which equaled a loss of 22.6% and February doesn’t seem so bad.
2. Many times, periods of intense volatility are a result of short-term factors, such as recent headlines in today’s 24/7 news cycle. Once those headlines phase out or are replaced by the next cycle of news, markets have a tendency to reclaim at least some of the momentum that was lost.
Facebook’s data privacy crisis, for example, has boosted the odds of coming regulation for social media companies, a potential obstacle to company profits. Since March 16th, the last close before the Facebook scandal hit, shares of the social media company fell 17.6% to close at $152.22 on March 27th. Since then, shares of Facebook have rebounded 6% to close at $164.68, as of this writing. That said, shares of Facebook still remain down 6.8% year-to-date.
Amazon shares have also come under political fire as President Trump weighed in on Twitter about the online retail giant. Amazon shares dropped 5.3% shortly after the President tweeted comments about the company but since have bounced 4.3% to reclaim most that loss. Year to date, Amazon is up 22.35%.
Similarly, shares of Tesla have taken a hit as National Transportation Safety Board investigators try to determine if a deadly March 23rd California crash of a Model X vehicle involved the company’s autopilot system. Since the crash, shares of Tesla fell 18.6% at their lowest, only to rebound 17.1% as of this writing. Shares of Tesla remain down 3.54 % year-to-date.
Finally, there is Apple. Although Apple hasn’t been in the news for data breaches or failed technology experiments, nor has it been the target of twitter attacks, it has been under pressure as a result of the trade tensions between the U.S. and China. In late January, Apple shares succumbed to the pressure and gave up 14.4%. Since then the stock has rallied back over 12% and is now positive on the year by 3.25%.
3. Why concentrate on the returns of large technology stocks like Facebook, Amazon, Tesla, and Apple? That’s because even if you don’t own a share of these stocks, their performance could very well have an outsized impact on the overall market. That’s right, the struggles that have recently engulfed some popular tech companies might be partially to blame for the intense volatility that we have experienced over the last two months. How’s that you ask?
Well, due to their popularity, tech stocks like Facebook, Amazon and Apple have become an increasingly larger part of the broader indexes. In other words, these tech behemoths, valued at hundreds of billions of dollars have a larger influence on the overall price movement of the broader market. In fact, technology stocks in the S&P 500 now account for nearly 25% of the index – up from less than 18% in the Spring of 2009. According to S&P Dow Jones Indices, Facebook, Amazon, Apple, Netflix and Google, by themselves, equal about 10.6 percent of the S&P 500!
This small group of stocks has become such a crowded trade since so many investors and funds have so much money tied up in them. When uncertainty about one name spikes, money comes out of that stock in a hurry, leading, in part, to the extreme market sell-offs we have witnessed this year.
Whenever markets fall people naturally look for a reason why. The reality, however, is that most times no one knows the exact reason. Markets are far too complex for one simple cause-and-effect relationship. That being said, it’s hard not to attribute at least part of the volatility to recent news about trade disputes, data security, and the ever-growing market weight of the most popular tech stocks, not to mention the threat of rising interest rates and inflation.
There’s a lot of uncertainty in the market right now and investors hate uncertainty. But there are also many encouraging signs as well. Strong corporate profits are anticipated this earnings season and earnings growth is expected to continue while the unemployment rate is expected to go down. Tax reform, combined with the nation’s economy inching toward 3% or better annualized growth, leaves plenty of constructive fundamentals for investors to focus on in the days, weeks, months, and years ahead.
Although day to day market moves can be alarming, strong fundamentals in the economy should drive stock prices higher over the long-term, although not without some ongoing volatility. So don’t get caught up in day-to-day headlines. Review your risk tolerance, and make sure you have a solid investment strategy in place. Work with your advisor to find an optimal asset allocation that fits your specific desires and needs, and please contact our office if you have any questions or concerns.