Quick Bites | Volatility is “the toll we pay to invest”

August has been a pretty difficult month for investment markets. Bond yields are sharply up, property markets look weak, equity markets around the world have fallen around 5-6%. But this is not at all unusual, and investors should not be unduly concerned. As market analysts say, volatility is part of the journey, and one should accept it as part of the process of price discovery.

Source: Sam Ro from TKer, Carson Research, Ned Davis Research

 

The chart above shows how common sell-offs are (this data is for the US market and covers over 70 years of the S&P 500 index). A 3% dip in the index can be expected to occur roughly 7 times a year. A 5% dip has historically occurred 3.4 times a year, a 10% correction typically happens once a year, and so on.

There are obvious reasons traders and investors might be selling:

  • Interest rates have been rising, offering alternatives to shares.
  • Economic growth has been strong, raising the risk of more hawkish monetary policy.
  • Valuations have been above average.
  • China, the world’s second-largest economy, is stumbling.
  • The Russia-Ukraine war continues and could cause another spike in energy or food prices.

Every major sell-off in history has been accompanied by a mix of economic concerns, monetary policy shifts, geopolitical tensions, or some other source of worry that might make a rational person demand a higher premium for putting their capital at risk. The details are different each time. But structurally, it’s generally the same story: it is risky out there, personal circumstances change, and so do investment objectives.

This is not to downplay any current concerns. Rather, it is a reminder that there are always things to be concerned about. In fact, it’s these ever-present uncertainties that hold back stock prices and explain why long-term returns in the stock market can be relatively high (say, around 10% on average for US and Australian equity markets over time).

Occasionally, a major risk will emerge that threatens the short-term outlook for earnings and warrants a major adjustment in the stock market. Whether that time is now (or not), can only be known in hindsight. In the interim, we have to rely on our best analysis, judgement and experience. Our view at present is stay the course, and in a year or two or three, you will be well ahead of the game.

 

 

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