Market Volatility: A History Lesson
- Market volatility has been ramping up throughout the month of September as historically it has been the weakest month.
- Typically, staying the course and continuing to invest has produced the best results.
September has been following its historical pattern of being a rather poor month for the market. The S&P 500 in the month of September has declined an average of 1%, going back to 1928. This could be exaggerated as the broader index hasn't experienced a market pullback or correction since last year. That could mean we are primed for downside pressures as investors are looking for a reason to sell.
A market pullback is typically considered when the averages decline 5 to 10%. A correction would be classified as a 10 to 20% decline from highs. Declines of greater than 20% would put us in a technical bear market.
Pullbacks happen pretty frequently. Going back to 1945 there have been 84 pullbacks in the 5 to 10% range. 29 declines in the 10 to 20% range and bear markets are fewer, occurring nine times since 1945. 40% declines or more, while not having a technical name applied to it (maybe we can call it a double bear market), have happened three times since that same year.
(Source - Guggenheim)
As we can see above, the time to recover is relatively swift for these more minor pullbacks. The time for recovery increases further, the deeper the declines. Another important consideration is that it takes less time for the slides to happen than the time it takes to recover.
The S&P 500 is down nearly 4% already this month now. This is measured by the SPDR S&P 500 ETF (SPY) in the chart below.
Data by YCharts
We've certainly seen a volatile tick-up as the VIX is heading higher. Market moves on September 20th really ramped this up. VIX is the measurement for CBOE Volatility Index. It measures the stock market's expectation for volatility based on the S&P 500 options. The higher that goes, the more investors will expect volatility. The chart below goes back 3 years to show last year's significant increase as March 2020 took over the market. We are still down considerably from that level but we have moved sharply higher this month now.
Data by YCharts
Overall, we've been having a fantastic year for the market, which was on top of 2020 also, strangely enough, ending up significantly from a period when we were down double-digits in March. The fastest bear market on record, followed by the quickest recovery on record. That just goes to show, no matter what those averages above tell us - each pullback, correction or bear market is unique.
Though it is worth mentioning that most of the deepest declines were brought on by a catalyst, the market doesn't usually just drop 20%+ for nothing. They are often black swan events that no one really sees coming.
What Is All This Information Good For?
The purpose of going over the historical data is to try to understand what could come next. As we touched on above, the deepest corrections and bear markets are often brought on by a black swan event. These are events that no one really sees coming.
Last year was a perfect example of this. Yes, we knew COVID was spreading throughout the world, but no one was really predicting the complete lockdown of economies around the globe. That just isn't something that happens at a mass scale. Thus, stocks and investments plunged.
I say all of this because that's why I stay primarily invested all the time, personally. The typical market cycle includes these pullbacks and corrections, despite how awful they can feel when going through them. Each significant decline in the market has had a subsequent recovery. So we are working with a long-term history that suggests we should continue to buy.
Data by YCharts
So what should our overall strategy be? It isn't some complex methodology that requires endless calculations. For those of you that are actively contributing (pre-retirement) to your accounts still, we buy every month. For our retirees, when we start hitting near all-time highs, we begin getting cash ready for the following buying opportunity (we take profits) and put those profits to cash. For many of you, your cash position will be your safe money bucket... whether that is an annuity or a defensive position in your portfolio. It's from these wells we can draw out cash to take advantage of the buying opportunities.
When do we start buying more?.. When we hit a 5% pullback. This is when we start putting cash back to work. For a pullback, we start buying a little. During a correction of 10%+, we start buying a lot. When we hit a bear market of 20%+ declines, we invest every cent possible. We end up being early more often than not. However, this strategy has served clients well over the years. We aren't at a pullback yet, but we can anticipate some opportunities. Who knows what Black Swan events lurk on the horizon?
Excepts take from Nick Ackerman