If 2020 was the “Year of the Pandemic”, 2021 definitely represented the “Year of the Recovery.”
On the surface it may not feel like we’ve emerged from the doldrums of Covid-19, but the economic data proves that we have made great strides. According to recent GDP numbers, we have not only fully recovered from the pandemic but also nearly returned to where we would’ve been if the pandemic had never occurred1. This bounce back was largely aided by historically low interest rates, loads of fiscal stimulus, an increasingly inoculated population, and efficiencies created by technological advancements.
Bigger Headlines, Smaller Rollercoaster
Not surprisingly, the stock market followed suit. As an encore performance to its surprising 16% return in 2020, the S&P 500 recorded a 27% gain last year2. These strong results came with historically low volatility. In fact, the largest pullback from an S&P 500 annual high was 5%, which is the third smallest drawdown in any year since 19801. In other words, investors were broadly rewarded for buying the stock market dips, or at least not selling when news headlines made you nervous.
Season 3 of the pandemic kicked off 2022 with a whirlwind of volatility. January was the worst month for the stock market since March 2020 with the S&P 500 recording a 5.3% loss3. While these pullbacks are never pleasant in real time, we find it very important to take a step back and analyze them from a big picture perspective.
Market Corrections: A Familiar Friend/Foe
The first thing to remind ourselves is that customarily stock market corrections are normal and to be expected. In fact, dating back to the 1920, the S&P 500 experiences a 10% pullback once every 16 months4. This specific correction is not surprising given that the S&P 500 has posted annual returns of 29%, 16% and 27% over the last three calendar years, respectively2. Long-term averages suggest a stock market return closer to 10%, so this 20%+ average annual return was not likely to be sustained.
We can also look under the hood of the most recent correction to try to make sense of it. We believe much of the selloff experienced in January was related to expectations for higher interest rates. This decision is being made by the Federal Reserve because they are seeing signs of a hot economy and high inflation. Raising rates is their way of regulating those measures and bringing them back to a more sustainable level. Over the long run, we think this will prove to be a healthy step forward. Remember: It is usually a good thing when your doctor says you need LESS medicine. Less Fed intervention typically means the patient is getting better.
Borrowing Costs: Higher, But Not High
Unfortunately, relatively higher interest rates typically force the stock market to reprice risk, which can happen very quickly in today’s age of supercomputer-based trading. Companies that were trading at high price/earnings multiples appear to have been hit hardest during this transition because their future earnings are expected to be impacted by a higher cost of borrowing. This explains why we saw a selloff amongst many of the tech companies that had gained so much momentum during Covid.
On the bright side, many of the unknowns driving the stock market volatility have become clearer. Largely, corporate earnings have come in strong thus far with 77% of the already reported S&P 500 companies beating analyst expectations3. Strong results from Apple, Microsoft, and Amazon were some of the main highlights from the past two weeks. Additionally, we remain in an environment that has historically low interest rates, a strong economy, and trillions of dollars in the money supply which could provide ballast to the stock markets.
While these volatile times can be unnerving, we recommend keeping a focus on your long-term goals. Staying the course has generally been the most successful strategy for long-term investors. We don’t expect that to change any time soon. Please remember that our team is always here to discuss any emotions you feel about investing and revisit the risk levels present in your portfolio.
- JPMorgan Guide to the Markets
- Fidelity Investments