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Welcome to The Long Term Investor. I’m recording on Tuesday, August 6 before U.S. markets open and the S&P 500 has fallen about 8.5% from its high over the last 14 days.
I actually had another topic ready to go for this week, but felt it was necessary to comment on the latest market movements. As someone that seeks to educate and guide others through financial decisions, I always struggle with whether or not to comment on these types of declines because, on one hand, I realize that they cause investors anxiety. On the other hand, I also know that this type of decline is rather routine.
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How Often the Stock Market Falls
Just looking at the S&P 500 since 1928, consider that:
- 94% of years experience a decline of 5% or worse
- 64% of years experience a decline of 10% or worse
- 40% of years experience a decline of 15% or worse
- 26% of years experience a decline of 20% or worse
This is actually the second 5% pullback in 2024, which is in line with historical averages. Again, looking at the S&P 500 since 1928, we average:
- 7.2 declines of 3% per year
- 3.4 declines of 5% per year
- 1.1 declines of 10% per year
- 0.5 declines of 15% per year (or one every 2 years)
- 0.3 declines of 20% per year (or one every 3.5 years)
As of this recording, we haven’t reached the point of a 10% decline, a level that most define as a “correction,” but we shouldn’t be surprised if that does happen. Similarly, we shouldn’t be surprised if there is a full recovery.
Below is a chart from JP Morgan that they update every quarter showing the S&P 500 intra-year declines vs calendar returns. As you can see, the S&P 500 averages an annual max drawdown of 14%, but in most years it recovers those losses and finishes the year higher.
What Triggered the Most Recent Stock Market Decline
While we can consider this market decline to be routine, you might still be curious as to why the market is falling.
Complex adaptive systems like the stock market movements can’t ever be perfectly explained in tidy cause and effect terms, but the prevailing narrative is that the job market is cooling to the point that recession concerns are heightened.
To be clear, the job market is still quite strong and this cooldown was somewhat expected after four years of being the economy’s bright spot. In fact, I think most economists would argue that the job market was too hot the past few years. But the labor market cooling combined with the Federal Reserve’s decision to maintain relatively restrictive monetary policy at its July meeting has led market participants to price in slower growth.
The Federal Reserve’s policy setting committee next meets in September and they are widely expected to cut interest rates now that inflationary pressures are finally easing and the labor market is showing signs of cooling. In my opinion—and mind you, I don’t make any investment moves based on my opinions or the opinions/forecasts of anyone else—I would expect the market to rally as the Fed cuts rates and if the following earnings season meets expectations.
What to Do in a Market Selloff
Given the routine nature of stock market declines, I developed a template blog post to use anytime the S&P 500 falls 10%. Each time it happens, I start with that as the template for what I want to say and make some adjustments based on the current market headlines.
Seems lazy, but the fact of the matter is that good financial advice doesn’t change. And, time and again, financial theory tends to prevail in the long run.
The four talking points are as follows:
1. Predicting the future is extremely difficult.
It is extremely difficult to predict the outcomes of macroeconomic events and even more challenging to predict how those events will impact financial markets. The market is made up of millions of participants, each using all available information and expectations of the future to drive asset prices to a very close estimate of the present value of future cash flows.
To make an investment based on a prediction is pitting your knowledge against the collective knowledge of all market participants. It is important to realize that your opinions and any information you hold (unless it is non-public information) is already mostly incorporated into current prices.
2. There is always uncertainty in investing. The future is unknowable and there are risks inherent to that. Our success in managing those risks will determine how successful we are financially. We never know when the next correction or bear market will happen, but we can manage our portfolios knowing that downturns will keep happening with a similar magnitude and frequency as they have in the past.
I’d argue uncertainty is a good thing because it allows stocks to provide returns above bonds and cash. When we look back at times in which there was high degrees of certainty about the future, we typically identify that type of sentiment as the symptom of a pending market bubble and precursor to a period of smaller equity returns.
3. Disciplined investing isn’t easy.
Stock investors are compensated for assuming the uncertainty of short term returns. To receive a rational premium for owning stocks over bonds and cash, stocks occasionally need to lose value.
Volatility is not the enemy and it works in the favor of long-term investors. High volatility in the short-run provides rebalancing opportunities while returns over longer time horizons tend to be less volatile. The long-term feels like an eternity to live through in the moment, but those that maintain discipline will be rewarded over time.
4. If you are feeling uncertain, review your financial plan before your portfolio.
Human nature, along with easy access to real-time market data, makes checking your portfolio the typical first response during periods of uncertainty. However, reviewing the underlying assumptions in your financial plan would be a better course of action because a thoughtfully crafted financial plan takes those periods of bad performance into account, and does so without emotion. As a result, you can know the comforts of your lifestyle are protected.
Resources:
- The Collective Knowledge Of Markets
- Evaluating Cash
- Volatility Is Not The Enemy
- Myopic Loss Aversion
The Long Term Investor audio is edited by the team at The Podcast Consultant
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