The Snooze-Button Stock Market
Have stocks really been "routed" and "roiled"? So far, not so much.
Here are two words investors may have encountered a fair amount in the last couple weeks when it comes to the stock market's performance: rout and roil. As in “the biggest rout on Wall Street in months” and “volatility continued to roil financial markets.”
We can add another word starting with "r" that investors should always consider: “reality.” Such as, “In reality, what have the markets been up to?”
This should be a go-to question for investors at any point. The reality check starts by looking at the context of “where” markets have been and a broad understanding of “why.”
From there, investors can begin to see whether recent swings in the market are a wakeup call that warrants a response or whether they should just hit the snooze button.
Lets start with “where” and look at the numbers.
As this column is being written on Monday, U.S. stocks are in the red, having posted broad-based declines in September. Last month, the Morningstar U.S. Market Index lost 3.5%.
Here's a look at the performance of U.S. stocks broken out by market cap and style. The red for September reflects the widespread sell-off. But investors should consider where markets have been beyond just the past month. For the past 12 months, it’s a sea of deep green. So far in 2021, the Morningstar U.S. Market Index is up 15%, which comes on top of a 20.9% return in 2020. Those are meaningful gains.
Before going deeper into the market’s performance, it’s worth looking at the “why,” with an eye toward weighing whether there has been news that materially changed the economic outlook, which could suggest that the market's downleg could have some meaning.
Some pundits have flagged it as bad news for stocks that the Federal Reserve signaled last month it could raise interest rates somewhat sooner than expected in 2022 in response to rising inflation pressures. Was this a game-changer? Given that monetary policy was still in economic-emergency mode against the backdrop of a recovering economy and rising inflation, most Fed-watchers weren't surprised. Most also believe that the Fed learned its lesson about roiling the markets (there’s that word again) from the 2013 taper tantrum and will continue to be deliberate and transparent in its moves away from easy money. (Morningstar’s economic outlook centers on continued healthy economic growth and only a temporary rise in inflation.)
What about other issues like those outlined here, ranging from jitters about the regulatory crackdown and Evergrande Group in China, to snarls in global production and shipping that are affecting a host of major industries. These are important to be sure, but are they trend-changing?
Stocks remain slightly overvalued according to Morningstar’s valuation metrics. Valuations do matter over the long run and can make the market more vulnerable to steep declines.
But with interest rates expected to remain relatively low even once the Fed begins tightening monetary policy, bonds don’t offer much competition for returns. As economist Jason Desena Trennert first wrote back in 2013, that likely leaves investors needing to grow their portfolio stuck in a “there is no alternative,” or TINA, situation.
What about that roiling volatility? In the final days of September, much was made of a one-day slide in the stock market of more than 2%. It was called the “biggest rout on Wall Street in months.”
At times, stepped-up volatility can signal a change in trend, particularly because it can reflect sentiment among investors whose portfolios are overly exposed to that particular trend--and who are beginning to head for the exits.
How much volatility has there been? We can see by looking at the daily moves in the Morningstar Large Mid-Cap Index that, for now at least, the 2% day on Sept. 28 was the exception, not the rule.
Overall, 2021 has been a relatively calm year for the scope of the daily changes in the Morningstar Large Mid-Cap Index, which captures the performance of large- and mid-cap stocks. For example, since 2010, the index has registered an average of nine down-2% days per year; in 2021 we’ve seen four.
Of course, daily moves tell just one part of the story. Just because the market isn’t showing lots of big one-day moves doesn’t mean portfolios aren’t taking a hit.
One way to look at this is by drilling down into cumulative pullbacks experienced in the market, as measured by declines from a record high to the next low point before the market recovered to set a new high. This is the same basis that investors use to measure so-called market corrections of 10% declines or more or bear-market declines north of 20%.
By this metric we can see that stocks have been grinding steadily higher since their 2020 pandemic lows with only brief pullbacks of 5%-10% and none exceeding 10%. On this basis, there isn’t much unusual so far in the scope of the recent sell-off or its timing.
When you compare 2021 against previous years on the same basis, this year has had a large number of smaller retrenchments. While it has been a strong rally, it hasn’t been one way. But then again, there haven't been a lot of market “routs.”
One caveat is that these stats have been for large-company stocks; 2021 has been a much more volatile year for small-company stocks. That’s not surprising given the uncertainty surrounding the course of the pandemic, the Delta variant, its impact on the economic outlook, and the often greater sensitivity of small-company stocks to economic growth.
Taken all together, the data presents a picture of a stock market that has so far experienced a fairly routine retrenchment. Of course, it's possible the September decline could be extended, especially if jitters grow around the debt ceiling battle in Washington.
But investors should always remember that most daily, weekly, and even monthly moves in the stock market are noise. In hindsight it’s possible there was information that turned out to prescient in those swings, but for now at least, the odds remain that as long as an investor has their long-term investment strategy in place, they will be able to hit the snooze bar.