Written by: Caleb Tucker, CFA®, Director of Portfolio Strategy
Market volatility has persisted throughout the first part of this year, with inflation and concerns about the path ahead for the Federal Reserve driving considerable swings in both equity and fixed income markets. The year began realizing that the Fed would have to take significant action to combat inflation. Not long after concerns over inflation and monetary policy began to escalate, we experienced one of the greatest geopolitical shocks in many years, with the tragic Russian invasion of Ukraine. The geopolitical situation only added to the concerns about inflation that were already present, pushing inflation higher and leading to the continued negative market sentiment. In short, it’s been an eventful and volatile year.
With regard to inflation, our view continues to be that while elevated levels of inflation will remain throughout this year, the pace of inflation will slow. The most recent inflation report for March supported this argument. While headline inflation came in slightly above expectations at 8.5% year-over-year, the core inflation number (that removes volatile factors like food and energy) came in below expectations. This is a signal that we may have seen peak inflation, or at a minimum, that inflation for core goods is leveling out.
As we’ve seen this year, the monetary policy response to inflation will be an important driver of market performance. The May Federal Reserve meeting concluded on Wednesday with an announcement of a 50 basis point hike to the federal funds rate, the largest rate hike since May 2000. The Fed also provided more guidance on the path forward for managing its balance sheet, which grew significantly as the Fed bought assets to pump money into the economy throughout the pandemic. None of these announcements were unexpected, but the immediate market reaction was positive as Fed Chair Powell’s comments after the meeting acknowledged the threat of inflation but still emphasized a strong economy. Furthermore, he took the prospect of 75 basis point rate hikes off the table going forward, which was welcome news to market participants. This dovish perception led to a strong surge in equities, but those positive moves were short-lived, with markets experiencing significant downward volatility the next day. The fact that the last 50 basis point rate hike took place ahead of the bursting of the dot-com bubble has driven some negative sentiment, but our view is that the similarities to that period are limited. Valuations were higher leading into the dot-com bubble1, and many of those companies lacked long-term business prospects. Today, the growth-oriented companies that have experienced some of the most significant declines this year are better-established companies, and corporate profits are stronger than they were in 20002.
When we experience bouts of market volatility, it’s important not to lose sight of the bigger picture and long-term goals. When a global pandemic was raging, and our economy was shut down in March of 2020, who would’ve expected the S&P 500 to finish positive that year, let alone up 17%3? During the Great Recession, unemployment peaked at 10%4 in October of 2009, and real GDP had declined by 4%5. Home prices had fallen over 31%6, and the overall sentiment was extremely negative, but the S&P 500 bottomed in March of ’09 and then returned 17.5%7 annualized over the next ten years. Two things are worth noting here. First, the market bottom came before the end of the recession. Markets are forward-looking and many times, the best days in the markets follow some of the worst, making it vitally important to stay invested despite short-term volatility. Second, investors who can stick to their long-term plans and stay the course can be rewarded for their fortitude. The annualized rate of return over the ten years following the Great Recession was well above the long-term average for the U.S. stock market.
Market volatility is a normal part of investing and is the reason why it’s so important to have a long-term plan that suits your needs throughout different market environments. Having a properly diversified portfolio with the appropriate amount of risk to pursue your goals could be a way to better navigate periods of market volatility. Don’t hesitate to contact your Merit advisor if you have any questions or concerns that we can address.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in this material may not develop as predicted. All investing involves risk including loss of principal. No strategy assures success or protects against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
All indices are unmanaged and may not be invested into directly.
- Source: Bloomberg. Based on Russell 1000 Growth Index P/E Ratio of 34 on 1/3/2000 vs 24.5 as of 4/29/2022. The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).
- Source: Bloomberg. Determined based on Russell 1000 Growth Index profit margin of 8.2% and current ratio of 1.2 as of 1/3/2000 as compared to profit margin of 14.5% and current ratio of 1.4 as of 4/29/2022. Profit margin gauges the degree to which a company or a business activity makes money, essentially by dividing income by revenues. The current ratio is a liquidity ratio that measures a company’s ability to cover its short-term obligations with its current assets.
- Source: Bloomberg. Based on S&P 500 Index total return from 1/1/2020 until 12/31/2020. Total return is a method for calculating all gains from an investment by factoring in both price appreciation and income generation over a set period.
- Source: US Bureau of Labor Statistics
- Source: US Bureau of Economic Analysis
- Source: SP Dow Jones Indices LLC. Measured by dividing the change in value of the S&P/Case-Shiller 20-City Composite Home Price Index between April 2006 and May 2009.
- Source: Bloomberg. Based on S&P 500 Index total return from 3/9/2009 until 3/9/2019. Total return is a method for calculating all gains from an investment by factoring in both price appreciation and income generation over a set period.