After a Bad Period For Markets, What Next?
Key Takeaways
News cycles can be negative, while the stock market continues to trend upwards.
Market sell-offs tend to feed upon itself, culminating in a few days of intense losses — but this is always temporary.
Most of the time, bad years are followed by good recovery years. The opportunity cost of halting or exiting your investment plan prematurely can be devastating to your goals.
How poor are they that have not patience!
— William Shakespeare
Last year was a bumpy ride for both stock and bond investors — ending more down than up. The multitude of bad news was linked to why everything performed so poorly. For this year, bad news continues with ongoing news of slowing economic activity and retrenchments. The Russian Ukraine war is also far from over. Yet global markets are up this year. So what gives?
This good example is a reminder of how unpredictable markets are and how divergent prices can be despite the news seemingly staying the same.
There is an old market cliche — “Stocks take the stairs up, but the elevator down”. And this happens quite often. Whenever there is fear and panic in the market, the sell-off feeds upon itself and culminates in a few days of intense losses. You can see from the chart below, it only takes a short while for prices to collapse (taking the elevator), but the market recovery then requires patience (taking the stairs).
Market volatility tends to rise during sell-offs so all the big market jumps occur during that period. When things calm down, volatility recedes and prices slowly grind upwards.
Another peculiar event in 2022 was the large hit that bond investors experienced (especially for high quality bonds). Many see fixed income as a safe haven, and usually bonds rise in value when stocks fall. However, this was not the case last year, and the double decline for both equities and fixed income was a once-in-50-years event.
Higher interest rates can bring short-term pain as bond prices fall, but they can be beneficial in the long term and present great opportunities for fixed income investors or investors who hold fixed income in their portfolios. For instance, higher yields usually lead to higher expected returns. Just barely two years ago, we were getting a 1% coupon (or less) on high quality bonds. Presently, we can get more than 3 time that amount on the same bond. As such, just doing nothing this year means you are getting a yield not seen since the 2008 financial crisis.
After such a bad year for both stocks and bonds, it’s worth noting that most of the time it is followed up by great years. Below is an overview of the returns from global stocks and bonds for the past half a century —
A caveat here is that market patterns are not always consistent, but you can see that whenever you experience large double-digit losses, the following recovery years are very fulfilling. Why this happens is that bear markets don’t last forever, and downturns bring prices down to levels that serve to provide attractive buying opportunities for long-term investors.
If you look at market history, bad markets in the early 70s were then followed up by many good years. Similarly, when stocks had multi-year declines in the early 2000s because of the dot-com bubble, we then saw many years of double digit returns. The terrible collapse of 2008 was then followed up by very good recovery years.
As an investor, if you look at what is happening in short timeframes of months or even a couple of years, then everything will end up looking bad. Zoom out with a 5 year or more perspective, and you’ll find that the pain is always temporary. Rebounds after steep declines help put you in a position for better long-term returns as markets recover. Even better if you have the guile and fortitude to allocate new capital during such periods — you will boost your long-term returns even more.
If you are thinking of selling, or stopping your long-term investment and savings plans, don’t. The history of markets shows that declines don’t last long and anyone who did so during past bad markets would be left regretting their decision when markets recover. It’s helpful to keep this and your initial reason for investing in mind so you don’t get left behind.
If you are unsure of what is happening in markets and need a second opinion on your investments, come and chat with us.
