For those who pay regular attention to the markets, if they’ve felt more volatile over recent times, you’re not mistaken. Periods of greater volatility tend to coincide with market drawdowns and 2022 was no exception. There were 102 days in which the S&P 500 Index had a move of one percent or more, significantly higher than in previous years (chart, below).*
Periods of downward volatility tend to be difficult, even for the best of us. Modern behavioural scientists suggest that we feel the pain of loss about twice as much as the pleasure of a similar-sized gain. Even medical doctors agree that “market volatility is bad for your health,” causing undue stress, generating feelings of worry and sometimes leading to poor decision making.
An Earnings Recession? Maintain Perspective
As we move into 2023, we expect periods of volatility to continue. With persistent inflation, the central banks are expected to continue raising rates to bring down inflation. Rate hikes are intended to slow the economy, which has prompted new concerns over a potential earnings recession.
While slowing the economy will put downward pressure on corporate earnings, there are reasons to keep perspective. Over the longer term, the stock market is driven by fundamentals such as corporate earnings. While the biggest bear markets often coincide with the largest declines in earnings, history has shown that changes in fundamental drivers, like earnings, may not necessarily lead to the same outcome. For instance, in the 1980s, earnings didn’t grow that much, yet the markets would post significant gains (chart). Indeed, there are many paths that the economy and markets can take. What if economies slow and inflation can be reeled in, yet labour markets remain relatively strong? What if earnings don’t fall much during the economic slowdown?
Are There Ways to Help Manage the Volatility? While it would be ideal to be able to hedge against the risks of slower earnings, inflation, rising rates or a recession, doing so would likely lead to a portfolio that offers a limited chance of upside. No one can consistently anticipate the timing of these changes, so, as advisors, we act as risk managers using strategies to help manage through difficult times. This includes having a plan in place based on individual risk tolerance and goals, using a disciplined approach that emphasizes quality, diversification and asset allocation and making prudent changes where necessary. For investors, having the patience to see through these periods is important. The same doctors suggest focusing less on our portfolios and instead getting exercise, eating healthy and engaging in activities like sports or meditation to worry less about volatility; perhaps good resolutions as we start a new year. After all, “attitude and perspective go a long way in both your health and investing.”
*When annualized. Data at 10/21/22.