April was a painful month for most asset classes.
Persistently hot inflation, geopolitical tensions, and China’s zero-tolerance Covid-19 policy dominated headlines. Needless to say, investor sentiment is at the lowest point since the global financial crisis.
The S&P 500 had its worst month since March 2020. Communication services and consumer discretion stocks took the brunt of the hit, down 15.8% and 13.1%, respectively.
Companies that derive the majority of their value on future growth expectations took a tumble into bear market territory this month. Other than the brief market drop in 2020, growth stocks have fallen from highs at the steepest level since the global financial crisis. A combination of rising rates and euphoric valuations appears to be the culprit.
The Federal Reserve seems to have lost its patience with inflation. Wall Street anticipates that the next Fed meetings will result in 0.50% interest rate increases - a faster pace than the originally anticipated 0.25% hikes – and that the Fed will soon begin unwinding its balance sheet.
Expected 10-year inflation is hovering around 2.8% as the 10-year U.S. Treasury climbed to 2.9%. U.S. Treasury 10-year real yields, or yields less inflation, rose into positive territory for the first time since 2020.
The University of Michigan’s Consumer Sentiment Index has already fallen below its 2020 lows and is sitting at lows last seen during the global financial crisis. Historically, these lows have been followed by strong stock performance.
Certain inflation measures appear to be rolling over. For example, inflation in the used-car market is now starting to fade – a big source of inflation pressure.
Consumer spending, which accounts for two-thirds of U.S. economic activity, remains resilient. Consumer balance sheets are stronger than in the past, and the global economy continues its reopening as the pandemic continues to ease.
Broadly speaking, corporations are reporting positive earnings. According to FactSet, 80% of reporting companies have beat analyst expectations. Companies such as Microsoft and Meta have helped ease investors’ nerves amidst the global chaos.
Time in the Markets, Not Market Timing
During bouts of extreme volatility, our emotions can often interfere with our rationality. As markets fall, our emotions tempt us to avoid further losses by selling at the most inopportune time, intending to return when things feel safer. This behavior is driven by loss aversion – the fact that losses feel more painful than gains feel good.
But what may not be obvious is that the worst-performing days are often closely followed by the best-performing days and just how important the best-performing days are for the recovery of an investment portfolio.
From 1930 to 2020, the S&P 500’s cumulative price return was 14,962%. If an investor were to miss the 10 best days each decade, that return would be a measly 91%.
In other words, a hypothetical $10,000 consistently invested would be worth $1,506,191. The same $10,000 would be worth only $19,101 if the 10 best days each decade were missed.
Looking at the past two decades, 65% of the best-performing days have happened within one week of the worst-performing days. Some have even happened the very next day.
During the rapid Covid-19 sell-off in March of 2020, the S&P 500 was down -9.5% on March 12, its second-worst day of 2020. The very next day, the S&P 500 was up 9.3%, its second-best day of 2020.
It is unlikely that one can miss the worst days and still participate in the best days because the best-performing days usually happen when loss aversion is at its highest. There is no clear “signal” that determines the market bottoms. In reality, most investors are locking in losses and likely missing out on the best days, eroding returns over time.
What It All Means
Investing success comes from focusing on what one can control, mainly coupling a disciplined, evidence-based investment approach with an appropriate asset allocation. Maintaining market exposure through a broadly diversified portfolio has rewarded long-term investors.
It is likely that the markets will remain volatile. There is still much uncertainty and ample unquantifiable risk around the impact of tighter monetary policy and global events. Historically, tighter monetary policy has been accompanied by solid subsequent gains, but we are also digging our way out of a health pandemic and attempting to understand the repercussions of geopolitical tensions in Eastern Europe.
For long-term investors, the outlook for stocks and bonds looks hopeful. Bonds now have higher yields, which also sets the table for higher expected equity returns. As illustrated above, success is achieved through time in the markets, not timing the market.
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