“A thing long expected takes the form of the unexpected when at last it comes.” Mark Twain
The respite from market volatility enjoyed in July and August was recently interrupted by a 2-week period that saw the S&P 500 drop over 5%. The Federal Reserve reiterated its hawkish commitment to aggressively countering inflation. Capital markets responded in turn by shedding over 1,000 points on the Dow Jones Industrial Average on Friday, August 27th.
There are a few take-aways worth considering:
- The Fed appears to be repeating a pattern out of their early nineties playbook; incremental yet aggressive rate hikes. And in the early nineties, it worked. The Fed tamed inflation without inducing a significant recession.
- Fed Chairman Jerome Powell feels the economy is on secure footing to withstand higher interest rates. Like chemotherapy as a prescribed treatment for cancer, higher interest rates “attack” the underlying causes of inflation by increasing the price of credit, but have other detrimental health consequences to the patient in the process.
Most importantly, periods of volatility remind investors that markets are cyclical. Specifically, over nearly 100 years of the modern stock market, the S&P 500’s daily close is positive only 54% of the time – nearly a coin flip. However, as the time periods are elongated, the probability of higher returns goes as the chart below depicts1. This should come as both a comfort and reminder volatility is the price paid for long-term growth in the stock market.
It is well documented that investors routinely underperform relative benchmarks not following a comprehensive strategy; not for reasons necessarily related to inferior investment selection, but because innate fear of loss lends to an emotional response to market volatility frequently resulting in poor investment decisions such as market timing. Interestingly, a study was conducted revealing an inverse relationship to investor performance with the frequency of monitoring account balances. The findings support the hypothesis that our perceptions of risk tend to be myopic.2
The antidote to this temptation is to remember your goals; expected rates of returns should be tied to portfolio investment objectives …not necessarily a benchmark that likely understates the diversification of a managed portfolio. We face a daily barrage from media incentivized to create short-term incendiary narratives enticing us to abandon disciplined behaviors that create wealth over the long-term.
It is reasonable to expect interest rates to normalize. Increasing inventories and recent Consumer Price Index readings provide hope that peak inflation may be behind us. Remember: the market is a forward-looking instrument. One such market indicator is the bond yield curve, which, when inverted, historically predicts recession. While the yield curve has recently inverted, it does not perfectly predict a recession’s duration or severity. Should the combination of increased supply and Federal Reserve-induced interest rate hikes tame inflation, then it stands to reason that the Fed would be equally poised to reverse course to stimulate the economy.
Market uncertainty abounds. I do not mean to downplay the psychological impact of seeing one’s net worth decline. I do mean to suggest taking a moment to acknowledge the normalcy of volatile markets is medicine to our beleaguered psyches. Whatever you feel, we invite you to reach out to schedule a time to consult about your portfolio and financial plan.
Thank you for your ongoing confidence. We look forward to connecting soon.
References
- https://www.fisher401k.com/sites/default/files/2018-03/Historical_Frequency_of_Positive_Stock_Returns_K03171V.pdf
- The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test. The Quarterly Journal of Economics, Volume 112, Issue 2, May 1997, Pages 647–661,. Thayer, Tversky, Kahneman, & Schwartz.
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