Volatility and Expectations
From Lee Sherbakoff, The Nalls Sherbakoff Group, LLC.
Fear and uncertainty linked to the COVID 19 pandemic have created mayhem in the stock market. As an investor, it’s easy to lose perspective and allow your worst instincts and emotions to overwhelm you. To gain some perspective, let’s look at what the evidence shows.
Let’s start by looking at drawdown—the peak-to-trough decline. The market (S&P 500 Index) reached a record high close of 3,386.15 just last month on February 19. Then, over the next 23 trading days ending Monday, March 23, the S&P 500 dropped 33.9% to 2,237.40. This was the quickest 30% drop in market history.
Does the market’s cliff dive afford buying opportunities? In a word, “Yes,” but it’s complicated. Buying low boosts the odds your expected return is relatively high. If you believe the market will return to the recent high of 3,386 at any time in the future then the move from 2,237 back to 3,386 is a 51.4% move, whether it take 3 months or 5 years.
But, of course, no one can identify the bottom in real time and so it’s never obvious when it’s “safe” to deploy new dollars into a beaten-down market. Nonetheless, at some point the selling will end and a rebound will begin. With the market so low, valuations have fallen, “giving equities more room to grow before they reach what we’d consider to be their fair value,” advises Joe Davis, global chief economist at Vanguard.
Market valuation doesn’t mean much for shorter-term horizons, which leads some investors to look for clues about expected returns in drawdowns—especially when peak-to-trough declines are sharp and steep. It’s even more important to manage expectations for longer-run horizons. That’s why your goals and objectives and your financial plan mean so much. Your plan contemplates short-term volatility and embraces long-term evidence-based expectations.
The good news is the expected return will rise if the market’s melt down continues. The danger is selling out at or near the point when expected return has surged to historically high levels which is when prices have dropped sharply.
The market can be generous at times, but it can be stingy, if not downright mean as well. As an investor, learning how to navigate and survive market volatility by managing your expectations and emotions are key to success.
The Nalls Sherbakoff Group, LLC
DISCLOSURES: The information provided in this letter is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal, or tax advice. The Nalls Sherbakoff Group, LLC makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of, or reliance on the information. These indexes reflect investments for a limited period of time and do not reflect performance in different economic or market cycles and are not intended to reflect the actual outcomes of any client of The Nalls Sherbakoff Group, LLC. Past performance does not guarantee future results.