U.S. stocks as measured by the S&P 500 finished the first quarter in slightly negative territory, having posted a fairly strong rally since early March. For the tech-heavy Nasdaq and the small-cap Russell 2000, however, the first quarter posted much steeper declines, as ‘risk-off’ sentiment seemed to disproportionately impact the higher risk, higher valuation areas of the market.
Even though stocks generally held up in the back half of March, I think it’s too early to declare the stock market correction over. I could see volatility persisting for weeks or even months from here – an outcome that would be normal, in my view, not worrisome. Short-term volatility is the price equity investors pay for attractive long-term returns. It comes with the territory. Going back to 1928, the average peak-to-trough pullback in a given year was -16.3%, and from 1928 to 2021, stocks fell at least -10% in 63% of the years. Corrections are common.1
Last year, the biggest pullback we saw on the S&P 500 was just -5.2%. Thinking in a historical context, if 2022 delivered one or two 10+% corrections throughout the year, investors should see that outcome as pretty normal – even though the factors driving sentiment lower feel ‘different’ and significant (inflation, Fed rate hikes, ongoing pandemic, and war in Ukraine).
Every market correction and volatile patch has a story tied to it, and it can be challenging for investors to accept that the market can do well even when there is war and soaring energy prices, for example. But stocks respond to earnings and shift earnings expectations over time, and right now we still see another year where S&P 500 companies are poised to deliver profit expansion. In the past month, profit estimates for S&P 500 companies went up, not down, even as the war escalated and crude oil prices soared.
The earnings outlook is one of the main reasons I think investors should remain patient even if the stock market re-enters correction territory from here. But there is also some pretty clear history around how the stock market performs once a correction has run its course. Since 1974, the S&P 500 has gone up an average of 8+% in the month following a correction’s bottom, and has risen an average of +24% one year later. A person can only participate in these rallies if they are fully invested at the bottom which almost by definition means participating in the downside volatility leading up to it.
2018 offers a useful example from recent history to demonstrate how corrections can persist and be a little sticky in a given year. Investors may remember 2018 was a year characterized by Fed rate hikes and the U.S. – China trade war. That year, the S&P 500 endured a Q1 correction of over -10%, then rebounded nicely into Q4 only to fall back into a correction by year-end. The S&P 500 finished the year down -4.4%.
In Q1 2019, however, stocks rebounded by more than +13%, and continued on a course throughout that year to finish up +31.5%. Strong returns often follow periods of downside volatility.
Bottom Line for Investors
No one truly knows whether the market volatility and/or the stock market correction has run its course – or whether there could be more turbulence ahead. I realize this is probably not a satisfying takeaway for many investors, especially given all of the uncertainty surrounding the ongoing war in Ukraine and rising energy prices. But I think investors can – and should – take solace in remembering that market volatility and corrections are not only common, but they’re also healthy. Markets need to reset valuations and investors expectations from time to time.
The war continues to be disheartening and disconcerting, but for now, it appears the conflict will remain regional – not global. The impact on the oil markets also appears to be better understood by markets and corporations, which may help explain some of the rallies we’ve seen in stocks since March. We will continue to monitor the situation closely and will offer updates if our views change.
Disclosure
2 Fred Economic Data. March 28, 2022. https://fred.stlouisfed.org/series/SP500
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