With the market selling off abruptly early this year, we wanted to reach out and provide a little color as to what is normal for equity markets and what is not, to help ease worry or concern for investors and potential investors. Although difficult in practice, this is not a time for panic! Not too long ago, we hit another all-time-high in the markets. We feel that the bull market is intact, the economy is still healthy, and fundamentals support higher prices from here. We also strongly believe that volatility will be higher this year.
Below we summarize a few key points that drive our investment philosophy and help put into perspective the market declines. We will discuss the volatility, fundamental, and economic landscapes.
Typical Market Declines
Below is a chart that illustrates historical intra-year declines vs. calendar year returns. You can see that most years’ experience drawdowns of more than -5%, and that most years have positive calendar year returns.
2017 was a year of unprecedented calm in the markets. It was an ‘abnormal’ market environment. We broke records for longest periods without a 3% and 5% decline. We broke additional records for the lowest amount of realized volatility. 2018 has experienced more volatility than all of 2017, which again is more typical of equity markets.
Below is a chart that shows that a 5-10% decline in the markets happens on average every year and that the average length of recovery is typically 1 month. Although unnerving, it is normal for markets to experience these types of movements.
Source: Ned Davis Research
Earnings growth is what drives stock market returns over the long-term. According to Factset, “For Q4 of 2017, the blended earnings growth rate for the S&P 500 is 13.4% with all eleven sectors reporting earnings growth for the quarter.” We’re seeing great earnings growth rates that have a tailwind of accommodative monetary policy and tax reform.
The main economic indicators we look include the unemployment rate, inflation levels, yield curve spreads, manufacturing indices, LEI, and others. Most, if not all our indicators, show a very healthy economy that is growing, albeit at a steady rate. We constantly monitor these indicators to be aware of unfavorable equity and market conditions expected in the future. Again, based off our indicators we don’t see any fundamental change in the economic landscape.
Stay the course and realize that markets are historically volatile – if there were no volatility, uneasiness, and risk involved with equity markets, there would be no potential reward and long-term returns. As the economic and fundamental landscape changes, we will make changes. Until then, stay the course.