When moving from Chicago to London about a year ago, I was offered some “settling in” tips as part of a relocation package.
Some were more mundane than others. For example, the classic “football” doesn’t mean “NFL” (although a walk down Regent Street this autumn might indicate otherwise) and ”pants” does not refer to the bottom half of a suit.
But the section that caused my London-based colleagues the most mirth dealt with that most British of conventions: queuing. Top tips from the handbook included the advice that Britons always queue, so this practice must be learned. Order will be maintained by fellow queuers and any authorities present, so follow their lead and be patient. It is typically not the done thing to converse with others in the queue, or comment on the length of the queue, to others waiting with you. And, most importantly, show no emotion in the queue either over the time or length of the queue.
Evidently, the handbook’s author thought Americans had never seen a line before. But in actual fact, the tips were a nice reminder that keeping calm when things get out of line is advisable – and worth it. This is certainly the case when it comes to global stock markets. Things got very out of order earlier this year, but for those who maintained their composure, avoiding emotional decisions in the midst of the chaos has already paid off.
Volatility is unavoidable in investing. There are many measures of market volatility, including the standard deviation of returns, the S&P 500’s VIX index and implied options. For long-term investors, the most meaningful measure may be the largest intra-year decline (or maximum drawdown) as it represents an investor’s largest loss during a given year. This week’s chart shows this measure for the S&P 500 relative to each year’s annual total return. These drawdowns can occur over days, weeks or months.
Having the fortitude to stay invested during these periods requires discipline that has often been rewarded. Despite median intra-year declines of 10 per cent, US equities provided a positive return in 27 out of 25 years up to 2014. For example, the maximum drawdown of 5.8 per cent in 2013 occurred when the US Federal Reserve began hinting at reduced asset purchases. There was saw a similar market pullback last year, when the market fell 7.4 per cent during October over a variety of global concerns. Despite the negative market reactions and subsequent volatility, neither episode was in reaction to underlying economic growth trends. Consequently, those who stayed invested during each year gained 30 per cent and 11 per cent in 2013 and 2014, respectively. This year, the S&P 500 fell 12.4 per cent at its worst decline, but the year-to-date return is reassuringly back up to 0.3 per cent, with still more than a month to go.
Investors should continue to expect stock market volatility as global growth concerns have emerged and the Fed becomes increasingly likely to raise rates. In this type of environment, it is even more important to distinguish between volatility that results from short-term news rather than long-term fundamentals, and to stay focused on the latter.
Historically, the market has pulled back 5 per cent, an average of four times a year, or about once a quarter. In fact, every year since 1995 has seen at least one 5 per cent pullback, with periods of elevated uncertainty, such as the euro area crisis in 2011, experiencing several. Despite this, the market has tended to fully recover within three months.
Drawdowns between 2 per cent and 3 per cent occur far more often, at least monthly on average, and have historically fully recovered within weeks. That is, short-term pullbacks happen frequently and should not be a reason for panic on their own. Broad market returns behave differently over daily, monthly and annual periods.
Daily market returns and volatility are asymmetric, meaning negative days are worse than positive days are good. This makes intuitive sense – although it takes a long time for the market to climb higher, it can fall quickly.
However, the fact that 53 per cent of days are positive offsets this imbalance. This is precisely why market timing is alluring to investors who are attempting to avoid losses, but also why doing so ultimately fails since gains occur more often.
In other words, patience is a virtue. Nobody likes to be stuck in a queue, but trying to cut ahead when things look grim is usually a bad idea. Although volatility is unavoidable, it is a reason for investors to stand firm and maintain a long-term perspective, rather than a reason for pessimism. After all, an investor’s sensitivity to market volatility is largely determined by his or her investment time horizon, and history shows that US equity markets have rewarded those who have stayed invested over longer periods of time.
Nandini Ramakrishnan is a global market strategist of JP Morgan Asset Management