2022 is off to a rocky start. The Omicron variant had an estimated 8.8 million Americans either out sick or caring for someone1 in early January, adding pressure to an already strained labor market. Inflation readings and gas prices show little signs of abating, and the Federal Reserve has pivoted to a more hawkish stance with interest rate increases in the offing. Geopolitical pressures are also building quickly between Russia and Ukraine.
As worries swirl, most major U.S. stock indexes have endured sharp selling pressure. What we’ve seen so far are double-digit declines over a very short period, largely on fears related to inflation, rising interest rates, the pandemic, and geopolitical flare-ups. In other words, investors are worried about recycled, widely-known, and understood fears – a classic sign of a correction, not a bear market.
If I had to give four defining features of a stock market correction, here’s what they would be:
- Sudden, sharp declines in equity prices
- Pervasively negative sentiment among investors and consumers
- No material changes to economic or corporate earnings fundamentals, which remain strong
- The ‘causes’ cited for the market correction are well-known, widely-discussed factors (in the current case: inflation, interest rates, Fed hawkishness, geopolitics)
I believe we’re seeing all of these features today. The latest American Association of Individual Investors (AAII) Sentiment Survey showed that bullish sentiment had fallen to an 18-month low, while bearish sentiment rose to a 16-month high. Only 21% of investors were bullish about the stock market over the next six months, compared to 46.7% of investors who are bearish. Investor sentiment is often useful as a contrarian indicator.
The last time investors were this bearish was in early September 20202, when inflation and supply chain pressures were all over the news, and as the Delta variant created headwinds in the economy. But we know the end of last year was not a good time to be bearish – the S&P 500 rose +11% in Q4 alone3. On the flip side, any time a majority of investors are bullish and euphoric about upside potential, it’s usually a sign to run the other way.
At the end of the day, downside volatility in the equity markets is always unpleasant, but it is also very common – over the last 42 years, the S&P 500 has experienced an average intra-year correction of -14.0%. Corrections happen all the time. In 2021, however, volatility was unusually low – there were only 55 trading days with moves of 1% or more in either direction (compared to 109 in 2020), and only seven days with a move of 2% or more. The biggest market pullback for the year was around -5%.4 A market correction in 2022 was to be expected, in my view.
The issue that often troubles many investors – and ultimately hurts them – is that they let volatility increase their temptation to “time the market,” allowing short-term uncertainties to drive their decision-making. But it’s important to remember that volatility works both ways. Rapid declines are often followed by rapid recoveries.
When an investor gets caught up in the negative news stories and sells into the downside of a correction, it often means capturing the losses but failing to participate in the recovery, which is a recipe for sub-optimal returns over time. Famed mutual-fund manager Peter Lynch once quipped that “far more money has been lost by investors preparing for corrections, or trying to anticipate corrections than has been lost in corrections themselves.”5
Corrections can lead even the most steely-nerved investors to make emotional knee-jerk reactions that adversely affect long-term returns. In my view, it is smarter to just stay the course and keep focused on the long-term.
Bottom Line for Investors
When the market takes a sudden and sharp turn, investors often get rattled and start questioning their asset allocation. Getting worried and second-guessing is a normal, natural, and understandable response. Volatility can serve as an opportunity to review your asset allocation and make sure your portfolio is diversified and aligned with your long-term goals. But if you’re feeling the urge to react and ‘do something about it,’ I’d strongly urge you to reconsider. If your goals have not significantly changed in the last week, then in all likelihood, your investment portfolio shouldn’t change either.
Disclosure
1 Wall Street Journal. January 23, 2022. https://www.wsj.com/articles/omicron-wave-drives-surge-of-workers-calling-in-sick-working-through-illness-11642933802?mod=djem10point
2 American Association of Individual Investors. January 20, 2022. https://www.aaii.com/latest/article/15894-aaii-sentiment-survey-bullish-and-bearish-sentiment-reach-levels-not-seen-since-2020
3 Strategas. January 2022.
4 J.P. Morgan Guide to the Markets. Slide 16. December 31, 2021. https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/
5 Acumen Wealth Advisors. April 8, 2018. https://acumenwealth.com/acumen-wealth-advisors-q1-2018-market-insights-commentary/
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