By Olivia Schwern and Federico Cuevas, JPMorgan
It was another week dominated by inflation, and markets felt the heat.
The higher-than-anticipated U.S. August CPI print (headline +0.6% MoM versus consensus expectations of +0.3%) catalyzed the worst day of performance for the broad equity market since mid-2020 (when investors were first digesting news of the Delta variant). The S&P 500 fell more than 4% on Tuesday, with longer duration growth stocks tumbling more than 5%. Heading into Friday, stocks had erased last week’s gains.
The 2- and 5-year Treasury yields popped +34 bps (basis points) and +25 bps to 3.90% and 3.68%, respectively, their highest levels since 2008, while the 10-year Treasury yield rose back to its highest level of the year (3.46%). The 2-year 30-year Treasury yield curve saw the most severe inversion since the Tech Bubble, Federal Reserve rate hike expectations for next week’s meeting climbed to 80 bps (implying a ~20% probability of a 1.0% hike), and the U.S. dollar remained hovering at 20-year highs.
Against such a backdrop, we thought it would be helpful to consider some other volatile periods to see what lessons we can learn.
5 Things To Consider When Markets Are Volatile
1. Big down days are tough, but staying invested is crucial
Since 1980, there have been 51 days during which the S&P 500 dropped more than 4% in a single session, as they did on Tuesday (only 0.5% of the time). Twenty-one of those days happened during the Global Financial Crisis in 2008/2009, and another nine happened during 2020.After each instance, the market never failed to recover and make new highs.
If this week shook your confidence in staying invested, remember the potential cost of getting out of the market. In the past 20 years alone, the S&P 500 annualized 9.7%, but missing just 10 of the market’s best days, which tend to occur within less than one month of the 10 worst days, would have reduced that annualized return to 5.5%.
2. Don’t miss the forest for the trees
Short-term returns for portfolios aren’t great. Over the last year, a 60/40 portfolio of U.S. stocks and bonds has been down -12.4%. Over the last two years, that portfolio has been up 5.8% (2.9% annualized). However, over the last three, five and 10 years, the annualized returns have been 6.2%, 7.3% and 8.4%, respectively. The present era of high inflation and an aggressive central bank tightening cycle is taking a toll, but the long-term track record is strong—we expect diversified portfolios to continue that trend going forward.
3. Understand the power of a diversified portfolio invested over the long run
While markets have bad days, weeks and even years, history suggests that you are less likely to suffer losses over longer periods—especially in a diversified portfolio. While rolling 12-month stock returns have varied widely since 1950 (from +60% to -41%), a 50/50 blend of stocks and bonds has not suffered a negative annualized return over any five-year rolling period in the past 70 years. Historically, the longer you stay invested, the more certain you can be about the range of outcomes.
4. Time flies when you’re climbing back to highs
Goals-based, multi-asset portfolios are meant to achieve financial goals through bull markets, bear markets, high-volatility environments, low-volatility environments, inflationary environments, deflationary environments, expansions, recessions, wars, pandemics and anything else short of the heat death of the universe.
With investor sentiment near all-time lows, the S&P 500’s previous all-time high (~4,800 in early January) seems like a distant memory. But this too shall pass. From current levels, the market needs a ~25% return to get back to previous highs. Even if it takes three or four years, the average annual return needed, 9% or 7%, respectively, would be right around historical norms.
5. Find value in murky waters
Through all of the daily volatility in markets and uncertainty in economic data, our objective is to build portfolios that allow investors to reach their goals with appropriate risk. It’s worth highlighting two opportunities that are offering compelling entry points.
For one, core fixed income is our highest-conviction idea that looks set to provide a buffer against potentially adverse economic outcomes. In the event that a U.S. recession does materialize and the 10-year Treasury yield ticks down from ~3.50% to 2.50%, we’d expect U.S. investment-grade bonds to return ~11%. If instead the 10-year Treasury rises to ~4%, U.S. investment-grade bonds would be flat.
In equities, we are making sure we have a proper balance between sector, style and size, with a tilt toward defensive and quality companies. Meanwhile, mid-cap equities are presenting an interesting opportunity. Current valuations are well below their long-term averages, compensating investors for a ~25% decline in forward earnings expectations—during the Great Financial Crisis, forward earnings estimates declined by 35%. Most of their revenue is derived from the United States, a value-add in a world of European energy and Chinese property sector crises. And finally, history shows a track record of faster earnings growth rates and exposure to stronger capital expenditures from large-cap companies.
In turbulent times, it is key to remember your core investing principles and consider capitalizing on windows of opportunity that the market presents.
About LRPC’s Monday Morning Minute
Lawton Retirement Plan Consultants, LLC (LRPC) Monday Morning Minute is crafted to provide decision-makers with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.
Lawton Retirement Plan Consultants, LLC (LRPC) is a Milwaukee, Wisconsin-based independent, objective Registered Investment Adviser (RIA) providing investment advisory, fiduciary compliance, employee education, provider management and plan design services to employer retirement plan sponsors. The firm specializes in sustainable investment strategies for retirement plans that incorporate Socially Responsible Investment (SRI) factors and Environmental, Social and Governance (ESG) elements. LRPC currently has contracts in place to provide consulting services on more than a half billion dollars in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or email@example.com or visit the firm’s website at https://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.
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