A relative calm in the equity market that persisted through much of 2024 appears to have expired. Over the last few days, a bout of volatility has emerged and has begun to garner substantial attention from investors. As is often the case, even those who don’t typically pay attention to the market or the financial media are noticing that something seems awry. The questions for many investors at this moment are:

1. What is happening?
2. Should I be doing something?

What is Happening?

By all accounts, the market was having an excellent year. By mid-July, the large US stocks of the S&P 500 Index were up over 18%. Since peaking on July 16th, however, the S&P 500 has declined by -8.5%. 

There are a variety of explanations for the decline. The most quoted include:

• Recent economic data has stoked fears of a recession
• The unwinding of the Japanese Yen carry trade
• Geopolitical tensions in the Middle East
• Seasonal weakness and a lack of market liquidity
• Berkshire Hathaway dumped some stock holdings, most notably in Apple

It’s impossible to know with certainty how much impact, if any, these individual factors have actually had on recent market moves. The reality is, for long-term investors, it doesn’t matter. The decision of what to do next does not depend on what caused the volatility, how long it lasts, or how bad it gets.

Should I be Doing Something?

For a diversified investor with a long-term plan, the answer is no.

There is always a reason to sell. The most successful investors will be those who can tune out the noise and stick with their investment plan. Of course, this is not always an easy task. The financial media profits off attention, and nothing garners attention like a good old-fashioned panic. Their reporting will try to convince you that this time is different, that the markets are melting down, and that you should be taking action. The truth is this time is not different.

As the table below illustrates, since the market bottom from the Global Financial Crisis in March 2009, there have been 32 distinct pullbacks where the market declined at least 5%. A handful of those episodes involved a severe market selloff.  

The above episodes ranged from mildly uncomfortable to excruciating. Some of the causes attributed to these pullbacks were unique, while others made repeat appearances. The common thread that links every one of them is that the investors who were able to stick with their investment plan would go on to weather the storm.

It is important to understand that bouts of volatility are a normal and healthy part of how the market functions. The chart below illustrates just how common large pullbacks in the market are. Nearly every year (93% of them) going back to 1929 had at least one market decline of -5% or more. Two-thirds of the years have had at least a 10% pullback, commonly referred to as a ‘Correction,’ while roughly one in four years have experienced a decline of 20% or more, which generally defines a ‘Bear Market.’  

Source: Morningstar Direct. Data from 1/1/1929 to 12/31/2023. Returns calculated from the S&P 500 PR USD Index using daily data. Excludes the impact of dividends.

Regardless of what ‘caused’ this recent volatility, there are a few things that we do know:

• The large-cap stocks of the S&P 500 Index have been on a blistering rally, gaining 36.9% between last October and the recent July peak⁽¹⁾.
• The Index is expensive by historical standards, trading at a 38% premium as of 7/31⁽²⁾.
• When the market moves as far and fast as it has and trades at such a large premium, it becomes prone to a correction. The ‘reason’ attributed to it does not really matter.

As I write this on Tuesday afternoon (8/6), stocks are up and have recovered some losses from recent days. Is this a momentary breather before the downswing resumes? Or are stocks poised for another rally? Only time will tell. Regardless of the market’s direction in the near term, long-term success requires tuning out the noise and sticking with the plan.

1. Based on the S&P 500 TR USD Index from 10/26/2023 to 7/16/2024
2. Based on the trailing 12 month Price to Earnings (P/E) ratio on 7/30/2024 relative to the average monthly P/E since 1/1/2001.

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION