Tug of War: Is the Market in Crisis?
The Ukraine crisis is top of mind for many, myself included, who are praying for the Ukrainian people and their safety, and a peaceful end to this senseless conflict. This sentiment was top of mind this week as I wrote my blog. Let's explore. Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
What the heck is a market correction? We're experiencing one right now. The Russian invasion of Ukraine had significant impact on world markets, but there's more to it. So, what does it mean for your retirement portfolio?
What Goes Up...
On February 23, 2022, the S&P 500 Index closed at 4,225.50, 11.91% below its all-time closing high of 4,796.56 on January 3, 2022. That percentage fall exceeds the "generally accepted" definition of a correction, which is "a drop of at least 10%."
According to the Wall Street Journal, "U.S. stocks fell Wednesday, deepening their losses after concerns over the Ukraine crisis helped push the S&P 500 into correction territory. The threat of war in Ukraine has added to uncertainty in global markets."
As an astute investor, I suspect you’re well aware of this early 2022 volatility. Other than experiencing a feeling of loss and a bitter taste in your mouth, how are you reacting to this most recent S&P 500 drop? Bitter tastes often lead to panicky selling, so let's talk about how to avoid making mistakes that could cost you in the long run.
Well, the first order of business is to recognize that market corrections are normal and somewhat routine. To drive that point home, some history is in order. Since it opened in 1926, the S&P 500 has experienced numerous corrections of at least 10%. The median decline has been about 20% and it typically takes the market over six months (about 194 trading days) to return to its previous high.
To add to investors’ anxieties, market declines of 5% or more have occurred about once per year – with an average decline of roughly 9%. Did some of those declines fit the definition of bear markets…drops of at least 20%? Yep, declines of 20% or more have happened 15 times – about once every six years - averaging 28% and taking about a year to recover. These early statistics were skewed a bit by the dusty 1930s Depression years.
During the more recent 72-year period since 1950, the S&P 500 has had an average (peak to valley) drawdown of 13.6% over the course of a calendar year. There have been 36 double-digit corrections, 10 bear markets and 6 crashes. In short, the S&P 500 has experienced, on average, a 10%+ correction every 2 years; a 20%+ bear market every 7 years; and a 30%+ crash every 12 years. Don’t be too dismayed by these correction statistics. Occasional short-term losses are why investors get high return “opportunities” over the long run – assuming, of course, they have the savvy to buy when stocks are cheap.
Timing the Market
Significant market corrections are not infrequent, but often they recover rather quickly. For this reason, "panic sales" are not recommended. In fact, most efforts to time the market, under any circumstances, are unproductive. If you have a history of trying to time the market, consider this old axiom:
Time spent in the market will provide superior results to time spent trying to time the market.
Panicky investors invariably find themselves grappling with two avoidable market timing questions:
Should I sell now (during a correction)?
(And if they do) When is the best time to get back in?
Impatient or panicky investors who follow the thundering herd not only risk selling quality stocks prematurely…converting paper losses into real losses…they also often create taxable events by taking gains prematurely. And then, it's anyone's guess on when is the best time to reenter the market. If they ever do they're usually too late.
If an investor’s timing is off in either instance, he or she will likely suffer unnecessary opportunity costs…1) associated with getting out prematurely, and 2) reentering a market very late in the inevitable recovery cycle.
Like taxes, market corrections are considered by many to be necessary evils.
But, on occasion, investor enthusiasm gets out of hand. 2021 was a good example of a "frothy market." Several years of above-average returns created an investor mindset that the stock market would keep on rising. Market risk was given less consideration than usual. Yet, risk and return are part and parcel of one another. For example, savvy investors correctly perceive stocks as riskier than short-term treasury bills; thus, investors buy stock in pursuit of a higher expected return. But if stocks always provided a guaranteed risk premium, the perceived risk premium would quickly fade.
Like “organizational slack” in companies, the stock market can become overvalued in the good times, and from time to time, must be trimmed of its excesses. From 1926 through 2021, the S&P 500 Index provided an annualized risk premium of 7% over those one-month T-bills, but astute investors should be ever mindful of the fact that in 25 of the 96 years between 1926 and 2021, the S&P 500 Index produced negative returns.
Risk Ain't Everything
Earning rewards results from more than just taking risks. During the 10 calendar years 2012-2021, the CRSP U.S. Total Market Index, which tracks shares of 99.5% of U. S. stocks from small cap stocks to behemoths, earned a 16.3% per annum return. It includes over 3,700 stocks with a median market capitalization of $1.4 billion. An individual investor would have had to display tremendous discipline during that same period while enduring 14 corrections of at least 5% (four greater than 10%) to earn a similar return.
It's ok to take risks, but also remember that Patience, Diversification and Quality are equally important components of the investment game. Yep, those PDQ principles are important to consider.
Age is a Factor
In addition to understanding the importance of risk/reward factors in investing, individuals need to understand these vital points about market corrections.
Younger investors in the accumulation phase of their careers should view corrections both as “necessary evils” and as opportunities to buy. Large declines provide investors (with well-designed portfolios) occasions to acquire stocks at lower prices.
However, investors in a withdrawal phase…retirees or near retirees…should view such corrections with greater caution. Periodic living expense withdrawals make it more difficult to maintain a retirement portfolio’s value over time. Risk, to this group, is perhaps the most important factor to consider at such times.
For both - the young and young-at-heart - discipline and patience are so very important. Markets are beyond the control of investors and can’t be outfoxed. Temperament, not intellect, becomes a most important quality when dealing with corrections.
So, exercise discipline. Stay the course. Alter your plan only if your need to take a larger or lessor risk has changed. But above all else, look at the data. Bull, bear and correcting markets have lives of their own…they represent both risk and opportunity…and they come and they go.