The calm is over.
One journalist described last year’s stock market as “placid.” Jason Zweig of the Wall Street Journal called it “abnormal smoothness.” Each of our past three quarterly letters made mention of low stock market volatility, with an admonition against getting accustomed to it. It was nice, but it also wasn’t meant to last.
The biggest overall dip for the S&P 500 in 2017 was a mere 3%. That was the smallest calendar year drawdown since 1995
. That level of calm was certainly out of the ordinary, as “intra-year” drops (peak to trough) have averaged more than 14% over the past 37 years
. Even since 2009 (a strong period for stocks), five of the eight calendar years experienced double-digit declines at some point. 2017 was definitely an outlier; volatility should be considered the norm.
What about the “historic” 1,175 drop in the Dow Jones Industrial Average on Monday? Headlines mentioning the “worst single-day point decline” for the Dow are simply sensationalism. Ignore the points – they don’t mean what they used to. Monday’s fall amounted to a 4.6% decline, which ranked as only the 99
largest daily drop in the index
(not a very exciting headline). It was a big drop, especially relative to the tranquility of 2017, but it wasn’t exactly apocalyptic.
But why? What caused the market to drop so quickly? You can find lots of possible explanations from commentators: stocks had gone “too far, too fast” and “prices got ahead of themselves.” Or, the economy started looking “too healthy” with stronger job and wage growth, which could lead to the Federal Reserve increasing interest rates at a faster pace. It’s easy to come up with a story retroactively to fit the circumstances. The fact is, we can never be certain what drove stocks on a particular day. Again borrowing from Jason Zweig, “searches for a rational explanation of Monday’s madness are futile.”
Investing in stocks requires accepting the intrinsic short-term risk in order to capture a long-term reward. Bonds generally lack excitement, but they also do a nice job of muting the gut-wrenching swings that can occur with stocks. It’s a tradeoff that we address when we help clients establish an investment policy. In 2017 it was very easy to own stocks, and we were grateful for their excellent returns. In 2018, we can now appreciate the stability offered by high quality bonds.
What are our recommendations in the current environment? The same recommendation we always make - take only the amount of risk you can afford and when the market swings, you can still sleep at night. Thankfully, the majority of our clients understand this and we appreciate you staying the course. Let us know your thoughts and questions.
The LPP Team
Strategas Research Partners
First Trust Advisors LP
The Wall Street Journal, Tuesday, February 6, 2018