Preparing for the next market correction

David Lebovitz, Global Market Strategist, J.P. Morgan Asset Management

March 2018

Key Points

  • Stock market volatility was historically low in 2017 but has picked up in 2018
  • Despite market shifts, overall economic conditions remain favorable
  • Portfolio rebalancing and a long-term investment focus can help investors through periods of market turbulence

The U.S. equity market ended 2017 on a high note, and this momentum carried over into early 2018. However, volatility made a triumphant return in late January, leading to a stock market correction in early February. With this episode of volatility behind us, we believe the path of least resistance for equities remains higher given healthy global growth, new U.S. tax legislation, continued low inflation, and a gradual normalization of monetary policy.

Why was volatility so low?

Many investors are asking why stock market volatility was so low in 2017. We believe there are several reasons.

  1. Years of easy monetary policy by the Federal Reserve and other central banks around the world helped drive stable economic growth.
  2. Policymakers have kept a close watch on financial stability, which has contributed to lower equity market volatility.
  3. Individual stock performance has been increasingly driven by company fundamentals, rather than by broad macro developments that can impact investors’ perception of risk. 

Additionally, more stable economic data, easy financial conditions, and a refocus on the fundamentals all seem to be at work.

Is more volatility expected?

We aren’t surprised by the recent uptick in volatility. Rather, we think this environment is far more normal than what we saw in 2017. It is important for investors to remember that volatility should be expected, as on average during the past 38 years, the S&P 500 has experienced declines of 14% during the course of the year.

Despite such negative fluctuations during any given year, in 29 of the past 38 years, the market has gone on to finish in positive territory. 

The question isn’t whether there will be volatility, but rather, whether investors have a plan, and more importantly, stick to that plan when volatility rears its ugly head.

Planning for turbulence

Volatility can make people emotional, which often times can result in poor investment decisions. This makes having a plan in place when volatility strikes a critical investment strategy. In our opinion, the best investment plan is one characterized by balance and diversification.

In fact, an individual who invested $100 dollars in a portfolio of 60% stocks and 40% bonds at the market’s peak in 2007 would have recovered their financial crisis losses in about eighteen months. By contrast, an investor who put that same $100 into equities only would have waited approximately three years to recover the losses suffered in the market decline that began in late 2007.1

Having a plan in place when volatility strikes can be critical to achieve investment success.

The general consensus is that many investors are not patient enough to live with losses in their investment accounts and at some point, may decide they’ve had enough. However, in doing so, they commit the quintessential investment mistake – buying high and selling low.

Positioning and rebalancing your portfolio for the future

The question isn’t about whether there will be volatility but whether investors are prepared for when volatility inevitably strikes. We believe that the best recipe for long-term investment success is a combination of balance, diversification, and maintaining an appropriate time horizon.

This approach should lead to a more comfortable investment experience. Chances are if investors can stay comfortable, they can stay invested. If they can stay invested, their chances of accomplishing their long-term investment goals improve.

Talk to your financial advisor to discuss investment strategies that are most appropriate for your circumstances.

 

 

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