By Stuart Robertson, Portfolio Manager, The Partners Group
Most major U.S. equity indexes have reached correction territory to start the year 2022 (defined as a decline of 10% from the last market high). Because it has been some time since we have seen volatility of this magnitude, the TPG Investment Committee felt it prudent to provide our thoughts in the light of the recent market activity.
The characteristics of a correction are a short, sharp, and steep drop of the markets of 10% or more. Typically, the root cause of a correction is a fear that affects market sentiment but does not have the ability to derail economic growth enough to cause a recession. With that in mind, we’ll examine the current catalyst for the drop, put past corrections in context and offer some final thoughts.
Fed Policy and Geopolitical Tensions Have Sparked Volatility
Markets have had a negative start to the year for primarily two reasons: 1) concerns over tighter Federal Reserve Policy and 2) geopolitical tensions in the Ukraine. On the Fed front, many prognosticators are expecting the Federal Reserve to begin raising rates to rein in inflation. Investors fear that the higher rates and a less accommodative Fed will spell doom for the markets. However, history suggests that rising rates is not a hindrance for equity returns. In fact, according to Goldman Sachs research, equity markets haven risen 5% in the six months following a first interest-rate hike since 1926.
As for geopolitical tensions, it’s difficult to handicap a potential Russian incursion into Ukraine. Russia has been amassing over 100,000 troops on the border with Ukraine since the end of 2021, and some level of conflict looks likely. This would be potentially more serious than Russia’s annexation of the Crimea back in 2014, but it’s impossible to predict the outcome of this event. Regardless, it’s a cause for concern given the range of possible outcomes.
Corrections in Context
Using historical returns, the market has seen 36 double-digit drops on the S&P 500 going back to 1950. In the past market cycle alone, starting from the 2008 Great Financial Crisis to the COVID Crash, the S&P 500 dropped six times by more than 10%. The average number of trading days from peak to trough was 88 days, with the longest at 157 days and the shortest 13 days. The causes of these drops were wide, ranging from the Taper Tantrum in 2013, Fed rate hikes, and geopolitical events—much like we are seeing today!
Source: CFA Society
Staying Disciplined Can Pay Off
Regardless of what we call market volatility, the question becomes what to do during periods of volatility. In times like this, the phrase “time in the market, not timing the market” is helpful to remember. The decision to pull money out of a long-term strategy is two pronged—when to get out, and then when to invest it back. The first provides emotional relief—stop the fear of “losing it all,” but the second is much more difficult. Markets never send an all-clear signal when the market has reached a bottom in a correction cycle. It is only with the benefit of hindsight—weeks or months later—when markets have rebounded that a bottom can be identified. Even then, sentiment or feelings about the market can still be characterized as despondency and depression (see figure 1). Paradoxically, this is also the point of maximum financial opportunity. Watching the market continue to erode stokes fear; staring at CNBC and Bloomberg will not do you any favors here.
It also brings to light opportunity cost: missing out on up days in the market. Missing even just a handful of the best days can be detrimental to long-term success. According to JPMorgan research1, an individual investing $10,000 into the S&P500 in January 2000 would have $32,421 by December 2020—an annualized return of 6.06%. Had you missed even 10 of the best days during those roughly 4000 trading days, you’d have just $16,180 for an annual return of 2.44%.
Short of a large exogenous shock, U.S. economic growth is likely to continue. Inflation and interest rates are unlikely to evaporate the trillions in growth expected to be added to the economy this year. It’s possible developments in Russia escalate to a larger conflict, but not very probable at this point. In our view, none of these worries spells doom for the economy in 2022. Though, as always, the TPG Investment Committee will continue to monitor developments. Discipline pays off—stay the course, ignore the noise, and focus on long-term plans.
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