Market volatility?! Two charts to help soothe investor worries

This article will ... Note that markets tend to work in cycles. Look at the lessons from comparing intra-year losses against total year returns. Point out the market performance following notable historic downturns.

The market recently took quite a sudden dip, causing lots of consternation.

• Should we sell?
• Is this the beginning of the end?
• Are we about to enter another Global Financial Crisis?!

Honestly? Markets just go down sometimes and, candidly, it can be healthy … particularly when viewed through the lens of history and rationality. I know that statement doesn’t make headlines, but it’s historically accurate and (I believe) fundamentally correct.

As such, what follows today is a (hopefully) rational and objective approach to what has occurred and a perspective on what may follow. Given the speed at which markets are moving, we are (unfortunately) going to skip the pithy anecdotes, introductory stories, and funny (to the author at least) repartee (although I have a great one on vegan paint that my dearest readers should see soon … ).

With that, let us begin.

We have met the enemy, and he is us…

Let’s start with some statements.

• Since 1928, the stock market has dropped more than 5 percent in 94 percent of the years and 10 percent or more in 60 percent of the years.
• Since 1928, the stock market has been negative 47 percent of the roughly 24,000 individual days and positive only 53 percent of the days.

It is the nature of markets, and it is the nature of humans. We create cycles and pendulums, and those pendulums swing both ways … and, frequently, too far to either side. This, to some extent, is human nature.

Which brings us to Chart 1:

The red dots show how much the Standard & Poor’s 500 lost in each year. So, in 1980, the market lost 10 percent, in 1981 the market lost 12 percent, and so forth. The blue bars, however, show the full calendar years’ returns for each year INCLUDING the losses. So, in 1980, even though the market lost 10 percent at one point, the full January 1st through December 31st calendar year return was 33 percent!

Squint a bit and you’ll notice three things:

• Every year there are losses.
• Most calendar years are positive.
• The average annual return has been quite strong.

This, of course, doesn’t mean the future will be the same. Yet if we believe capital markets are representations of capitalism, and capitalism is driven by human incentives … then there is every reason to believe the future will likely rhyme with the past as:

Human nature hasn’t changed.

Those incentives still very much exist.

Yes, but what if…

Inevitably, the question remains: What if this week’s sell-off is the start of the next “big one”?! In October 1987, the market fell 20.5 percent in a SINGLE DAY! In 1974, the market fell 50 percent, and in 1929, the market lost nearly 90 percent!

There are two ways to approach this question: the current environment and with historical perspective.

As to the first, in the United States, we are currently in an environment with:

• Very low unemployment.
• Low(ish) and falling inflation
• The world’s most sophisticated central bank (which, yes, is likely a little behind).
• A growing economy.
• A very sophisticated (albeit occasionally flawed) banking system.
• The world’s most liquid and diversified capital market that not only provides capital for productive purposes, but also provides incentives for ingenuity and innovation.

Is the market a tad expensive? Yes. Is the market a bit optimistic? Yes. But given the above, I see no reason to believe equity markets will not continue to produce returns above inflation for those that provide capital for productive purposes.

As to the second, Chart 2 provides a historical perspective.

Historically, I take two things from this chart.

• First and foremost, when left invested, U.S. equity markets have generated remarkable returns for investors.
• Second, the massive generation-defining crises have largely disappeared into the distance with enough time.

The “dot com” bubble bursting changed an entire generation of employees and risk taking and yet is largely unnoticed in the chart above. The Black Monday of 1987 would be hidden if I hadn’t highlighted it, and the Global Financial Crisis … what was referred to as “the end of capitalism as we know it” … is a mere blip on the radar now that enough time has passed.

In short, focus on the long term and try to ignore the short term. Capital markets (as a representation of capitalism) are alive and well and, while it’s likely to be a bit volatile in the near term, I lean toward this being the market “throwing its toys out of the crib,” and not a major turning point.

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