Talk about starting the new year off with a bang! Volatility has re-emerged with a vengeance, making this one of the most volatile Januaries in history. Both equity and bond markets have felt the impact. Even most cryptocurrencies have declined by at least ~25% despite being viewed by some as a “hedge” against market volatility.

A sharp spike in volatility like this can feel scary, especially when it seems like there is no place to hide from it. When this happens, it is important to take a step back and remind yourself of a few things.

Volatility

Volatility is normal and what makes markets function. You should expect and embrace volatility over your investing lifetime. In fact, when markets surge as much as they have since April 2020, future volatility should be expected to increase.

While we are close to correction territory as I write this, it has been almost two years since the last correction. I would go as far as saying the lack of volatility before this month should be viewed as an abnormality. Since the start of 2018, there have only been two market corrections, which is saying something given all the uncertainty we have endured.

As a refresher, a correction is a market decline of 10% or greater. A bear market is a decline of 20% or greater. On average, a correction takes place every 1.6 years, and currently, we are knocking on the door of two full years. This time span is even more impressive when you factor in that we have been in a pandemic the entire time.

In short, volatility is part of what makes markets, and the fact that we haven’t experienced a correction in nearly two years is a bit mind-boggling.

Since 1946, there have been 84 declines of 5% to 10% in the S&P 500, which works out to more than one a year. The most impressive part is the bounceback. On average, the market recovers from these losses in a matter of ONE MONTH!

Time Horizon

The most important variable with investing is time. The longer the time horizon, the better.

Generally speaking, any funds you need within a three-year window should have little to no market risk. If your time horizon is over 10 years, you can view market corrections as a blip on the radar and as an opportunity.

The S&P 500 has experienced only three market declines greater than 40% dating back to 1946. That comes out to one in every 25 years! An investor with a long-term time horizon should not panic as it has generally taken less than five years to recover from the drop.

If you have a long-term time horizon, you would have more than enough time to watch your portfolio bounce back.

Also, this should go without saying, but as you approach retirement or need to access funds, you will want to adjust your risk tolerance to reduce the volatility in your portfolio.

Federal Reserve

We have to come to grips with the notion that the Federal Reserve will be less accommodative moving forward. For the better part of the last 10 years, the Federal Reserve has stepped in to help both equity and bond markets during periods of volatility.

With the need to raise interest rates to combat stubbornly high inflation, the Fed will likely step back and allow the economy to stand on its own two feet. There is no way to tell how this action will play out, as we haven’t been in this position since before the financial crisis. This lack of predictability means we should anticipate more volatility ahead, but not necessarily a market crash.

The Federal Reserve’s goal is to provide the U.S. with a safer, more flexible, and more stable monetary and financial system. They accomplish this through various mechanisms, one of which is assisting stock and bond markets in times of need.

Does this mean the Fed is completely exiting? Of course not. But the frequency of their involvement is likely to decline over the coming years.

Panic

Panic is never a strategy. When markets drop in a short time, it can feel like it’s only going to get worse with no end in sight. Since 1946, the S&P 500 had had nine declines between -20% to -40%—so about once every 8.5 years.

This should tell you that most market drops are not as severe as we fear they will be. In addition, the recovery tends to be much faster than we anticipate.

The reality is corrections should be viewed as a normal process for markets. While never enjoyable, each one can be viewed as an opportunity. Trying to make sense of short-term market movements is a fool’s errand, as frequently they aren’t based on fundamentals and more so on market momentum and other factors.

There is no denying that the returns since the Great Financial Crisis have been a bit of an anomaly. The Federal Reserve and global central banks have done their part to help elevate markets. With their desire to become less involved, there could be a case for lower expected returns over the next decade. This is not an unrealistic assumption, but it does not mean we are headed for a crash.

In the end, control what you can control, and do your best to block out the noise. Consider working with a fiduciary financial advisor who can help you stay objective no matter what the markets are doing.

Discuss your situation with a fee-only financial advisor.

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