The start of 2022 has been a challenging one for investors. In the month of January, stocks were down 5.3% with some areas such as the Nasdaq losing nearly 9%.1 This comes amid a wall of worry related to the surging Omicron variant, inflation fears, and anxiety related to the Federal Reserve’s desire to increase interest rates. While it’s certainly plausible these fears could derail the U.S. economy, history suggests these fears may be overblown. Consider in the last five years a stock market investor would have more than doubled their money, despite multiple pullbacks along the way.2 Pullbacks are market drops that tend to be less than 20% and often correct themselves in less than 12 months.3 In that time, we’ve dealt with Brexit, the possible collapse of the Eurozone, the government shutdown of 2018, multiple impeachments scares with former president Donald Trump, the North Korean missile crisis, and a global pandemic, unlike anything we’ve seen since 1918. Despite all these challenges, the U.S. economy grew by 5.5% last year, which is the best growth rate since 1984.4
These pullbacks can cause a lot of anxiety along the way, but hindsight shows us overreacting to them would have led to suboptimal results. Investor selling during pullbacks is the main reason research has consistently shown over long periods of time that stocks earn an average of 10%, while the average investor makes just 2.3%.5 This atrociously bad number, comes down to fear, which can completely paralyze us at the worst possible time, leading us to sell our investments when we should be holding and/or buying. This is not to say we should never play defense; in fact, while pullbacks cannot be avoided, market crashes are the real enemy and most investors would be wise to adjust their portfolios to soften the blow. Market crashes (like the financial crisis) can take years to hit bottom, typically wipe out nearly half an investor’s money, and could take a decade to recover from.6 How does one know the difference? Simply put, market crashes tend to correlate to recessions. Over the past 50 years, there has been an 83% correlation between a market crash and a recession, while pullbacks have only shown a 38% correlation.7
If we can understand when a recession is coming, we might be able to prepare for a market crash. With an economy posting some of the best growth numbers in 40 years, and most leading economic indicators pointing to an expansion, the probability of recession is low.8 And while investing never affords us the luxury of absolute certainty, we can confidently say the latest market volatility is a pullback, not a market crash. Investors would be wise to temper their anxiety and not overreact to the current volatility. Just like it did in the past, we believe the current downtrend is temporary and will likely correct itself later this year.
Source: 1,2, 4 & 6 yCharts.com
Source: 5 Dalbar – Average Investor Return
Source: 3,7 & 8 Anatomy of a Recession – Clearbridge Investments
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