Reflections on Recent Stock Market Volatility


David Sowerby, CFA, Managing Director, Portfolio Manager

Recent activity in the stock market has once again reminded investors that prices correct, and when they do, it can test the will of those claiming to be long-term investors. The S&P 500 has corrected 8% since late January and done so rather abruptly in the past week. The average S&P 500 stock is now off 15% from its 52-week high.

When the market witnesses this quick of a decline, we are often queried for the causes. In this particular case, investors were well aware that the market had witnessed over a year and a half of above average gains, without even a setback of 5%. This recent decline is primarily the result of higher than expected interest rates over the last month. To be sure, there were additional factors, including greater investor complacency and concerns that many assets were getting overvalued, to name but a few. As usual, when corrections occur, it is often easy to identify the causes.
In this case, not only the causes matter, but more relevant is the assessment of how deep this decline might be. More specifically, are recent events the start of a 20% or greater “Bear” stock market? When reviewing the main elements that historically signal market tops and impending Bear markets, this recent decline has few of those factors. More likely this is a more normal, but nevertheless unpleasant, 10% stock market correction which could well linger for multiple weeks.

A quick review of the U.S. stock market history shows that corrections occur once a year on average. In contrast, Bear markets of 20% or more occur about once every 3 ½ years. Importantly, the chances of a 10% setback becoming a more severe decline of 20% or more is about one in three. That likelihood is further reduced against the backdrop of an expanding economy and healthy corporate profit growth. The traditional Bear market indicators such as heightened M&A activity, poor capital discipline exhibited by companies, inflation rates above 4% commensurate with meaningfully higher interest rates and significant high yield bond market weakness, all of which foreshadow major stock market problems, are quite limited.

In closing, the recent stock market weakness could well linger for multiple weeks. Stock market data for the last fifty years shows that the average 10% type correction takes approximately four months on average to recover. For example, in the current Bull market we have witnessed corrections in 2010, 2011 and the most recent in early 2016, each one lasting for multiple weeks. Fortunately, for the majority of investors, their time horizon is longer than that. So, while we expect this heightened volatility and potential for down days to linger, our commitment to building enduring portfolios comprised of companies and strategies that are shareholder focused with superior capital allocation discipline and trading at more compelling valuations, is unwavering.

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