It has been difficult to find much market commentary that suggests positive developments in the financial and economic markets over recent times. The reasons are many: high and persistent inflation, more aggressive tightening policies by central banks and the prospect of recession. This has created significant uncertainty over the path forward.
Indeed, humans can react unfavourably to uncertainty. Studies have shown that our emotions are a key driver of stock market volatility over shorter periods. One study suggested that roughly 75 percent of short-term market variation can be explained by risk aversion. This is likely because, in the short term, we underestimate our ability to adapt.
Today is no exception. We have seen significant volatility in the financial markets. Market pundits have been having a field day creating worry that this time is different. However, some perspective is warranted. Let’s not forget that, over time, economies and financial markets have continued to adapt and progress. We have also come from a time in which record stimulus benefitted both the markets and economies, so a period of adjustment can be expected. Many company earnings that thrived over recent times must now adjust as consumption patterns balance towards a post-pandemic world. High inflation has been a prevailing headwind and although it has been more than just transitory, consider that it will also not be permanent.
Economies, like the markets, are cyclical in nature, so anyone who forecasts a recession has a good chance of eventually being right. In Canada, first quarter GDP grew at a rate of 3.1 percent. Although GDP contracted in the U.S., labour markets in both nations continue to be robust and, for now, household balance sheets suggest consumer resilience. We should also remember that recessions vary in their duration and intensity; the past two lasted only three and seven months.
This is not to suggest that there aren’t challenges ahead. We have entered a period of slower growth globally and continue to face many uncertainties. As such, it may be difficult to not take action when experiencing market pullbacks. However, for investors who may feel the urge to sell investments for fear of a greater loss during these times, this can create two issues — selling at low prices and the inevitable need to re-enter the markets. Consider also that the biggest up and down days have historically clustered together and missing the market’s best performance can significantly impact future returns. And, it’s not just the inherent difficulty in timing the market: Selling and rebuying can potentially create a costly tax situation in certain accounts or forego dividend income opportunities.
Consider also that one of the most important variables for how you’ll do as an investor can be how long you are able to stay invested. This is because success for many investors comes from uninterrupted compounding over years and decades. In the words of renowned investor Charlie Munger, Warren Buffett’s business partner, “the first rule of compounding is to never interrupt it unnecessarily.” Don’t overlook the importance of holding on.
We understand the challenges that come from an uncertain near-term outlook. During periods such as these, investors should try to stay focused on longer-term goals. Keep your eyes on the horizon, stay invested and look beyond today, as better times will eventually prevail.
This article was originally published in the Summer 2022 newsletter, "Challenging the Trend." Click here to view.