After three consecutive years of above-average gains, equities are now in the midst of a pullback that has many investors wondering what their appropriate response should be. It is important to know that such declines are (1) temporary interruptions in the long-term wealth creation engine known as our free-market capitalistic economy, (2) cannot be predicted (or timed) with any consistency, and (3) tempt those who respond inappropriately to put at risk the ability to reach their life’s goals.
It may help to revisit the definitions, depths, and frequency of various market declines. A correction is typically a pullback of 10% or more, whereas a bear market is viewed as a decline of 20% or greater. Since WW-II, the S&P 500 has experienced an intra-year decline about every 1.3 years, averaging 13.7%; some years more, some less, so the current selloff is well within the expected norms. Every 3-5 years an investor might expect a decline of 20%-30%, and even less frequently, a pullback of 35% or more. There have been three major bear markets since the Great Depression, each of which delivered a peak-to-trough drop of 50%. In every instance of every decline, great or small, the market recovered and eventually reached new highs. This is no coincidence, but the reality of a stock market that reflects the underlying economy, which itself is in a perpetual state of growth with an occasional recession.
While each market sell-off may have a different causation, they are all fueled by uncertainty. As we enter 2022, it is uncertainty related to the possibility that interest rates may rise faster than expected, that elevated inflation will remain longer than hoped, that earnings growth is slowing, that Russia may invade the Ukraine, that North Korea may become more belligerent, that…well you get the picture. Different cause, same uncertainty. While the concerns are real, they should not overshadow another reality. On average, equity markets go up about 70% of the time. That’s because the economy is growing 70% of the time. Those are pretty good odds for anyone willing to remain invested and even better odds if one views such selloffs as opportunities to buy shares of the world’s greatest companies after they have been put on sale.
Investors who have engaged in a comprehensive financial planning process through which they clearly define their life’s goals and objectives, identify current and future resources needed to fund those goals, and adopt an asset allocation policy that balances risk and return already understand the impact of market volatility on their portfolio and are able to tune out these temporary distractions. They realize that the most appropriate response to a market selloff is often no response. Some investors might even consider increasing the purchase of equities at these points of greater opportunity. It’s easy to say, but hard to do.
Stay the course.