Market Volatility: Part of the Plan

Stock market volatility is back.

We’re here to hopefully provide some context and perspective.

If you takeaway anything from this message, it’s that stock market volatility is normal, it’s expected and it’s part of the plan.

Okay, so let’s start with what’s happening.

What’s happening:

• Inflation hit a 30 year high in Canada and a 40 year high in the U.S.
  • As a reminder, inflation is a loss of purchasing power of money, meaning your dollar will not go as far tomorrow as it did today due to the increase in price of goods and services.
• The current high levels of inflation relate to demand exceeding supply
  • Demand – economies are opening up + consumers are in a better financial position than pre-pandemic + pent up demand + cost of borrowing at historical lows.
  • Supply – pandemic caused supply chain shortages (ex. I just bought a couch and was told it would take 7 months to arrive).
  • In general, when demand exceeds supply, inflation increases.
• In order to prevent potential hyperinflation (prices getting out of control), the Bank of Canada or the Federal Reserve in the US will raise interest rates.
• Increasing interest rates causes the cost of borrowing to go up and therefore keeps a lid on spending, in hopes of curbing inflation.
• Although we all knew at some point interest rates would need to rise, the catalyst for the recent pullback relates to Fed Chairman Powell’s November speech when he indicated that inflation may not be “transitory” and thus the Federal Reserve may embark on a much more aggressive tightening cycle (i.e. pull money out of the economy + raise interest rates).
• When interest rates rise, high priced growth stocks in particular, get hit the most (think technology) in the short term, especially speculative technology.
  • WHY: higher interest rates means higher future costs for companies, which means the price your willing to pay today for the future earnings is now lower.
• Remember, this is not because a breakdown in the housing market or financial system.

Here’s some perspective:

• We should expect market corrections –
  • Since 1950, the S&P 500 has had an average drawdown (drop) of almost 14% over the course of a calendar year;
  • Meaning we should expect a 14% drop at some point during the year.
• Stock market corrections are normal –
  • Since 1950, there have been 36 double digit corrections, 10 bear markets (20% drops) and 6 crashes;
  • Therefore on average, a correction happens once every 2 years (10%+ drop).
• 2021 was a year of great returns with almost no volatility –
  • The market as measured by S&P 500 (500 largest companies in the US) was up 28.7% with the worst correction being 5.2%.
  • In 2021, there were 70 new all time highs (nearly 1/3 of trading days).
• The last 3 years have been great –
  • 2019 = fantastic investment returns.
  • 2020 = average return.
  • 2021 = fantastic investment return.

This was expected:

• Volatility would eventually return –
  • Markets do not go up in a straight line – it’s 2 steps forward, 1 step back
• Remember interest rates around the world were cut to basically zero in 2020 as a necessary step to keep the economy afloat.
• At some point, we knew that inflation was a possibility and that interest rates would need to rise which could cause a market correction.
• This is a necessary part of market forces.

We’ve been here before:

• You’ve been through this a number of times in the past few years.
• End of 2018, the US market dropped 19.8% and recovered by April 2019.
• Covid 2020, the US market dropped 34% and recovered by the summer of 2020.

Volatility = Opportunity

• The portfolio managers are currently upgrading your portfolio, meaning they are buying quality companies at a cheaper price –
  • Think Amazon which has dropped 10+%. Do we think Amazon is going broke? Likely not, so we can now buy Amazon 10% cheaper.
• We know that moving to cash or fixed income is not beneficial especially in an inflationary environment.
• Equities (stocks) outperform inflation over time.

Part of the plan

• Although uncomfortable, stock market corrections are a healthy and an important part of markets.
• Your asset mix or “portfolio recipe” which accounts for 85%+ of your return is stress tested against market drawdowns of 25%+.
• 2018 and 2020 has reminded us that market timing does not work.
• Remember the 4 most dangerous works in investing – “this time it’s different” –
  • It’s always a different cause, but same result.

We’re here and available if you’d like to chat!

Talk soon, on behalf of the entire team at Surround,

Adil Mohammed, CFP®, CIM®, FCSI®
Wealth Advisor
Assante Financial Management Ltd.