- Short-term performance swings are largely driven by fleeting market sentiment.
- We believe investors can prepare for and soften (but not eliminate) the impact of drawdowns through prudent diversification rather than emotional reactions.
After ringing in the decade on a high note, investors were caught off guard by the extreme volatility that ripped through capital markets in the first quarter of 2020. March brought a degree of turbulence not broached since the global financial crisis, with a sharp equity-market drawdown (peak-to-bottom decline) that overshadowed the similarly-shocking fourth-quarter 2018 decline. In the years leading up to these shocks, equity investors had been spoiled by prolonged market rallies, relatively muted pullbacks, and sustained periods of low volatility. The swiftness of the declines has served as a stark reminder of just how volatile equity markets can be — particularly the recent shift from above-average annual performance to bear-market territory (a drawdown of more than 20%) in a matter of months. While these sudden lows can feel painful in the moment, it is important to understand they are part and parcel of the risk an investor must bear to earn equity returns.
Significant market declines are fairly common and represent an inherent part of equity investing. While few investors like to see stock markets fall, there are approaches to investing that can help mitigate the impact of downturns, including:
- Reflecting regularly on whether your investment strategy is aligned with your investment goals (in that it may help you avoid incurring more risk than is necessary)
- Maintaining prudent diversification
- Refraining from reacting emotionally to short-term market movements
First-quarter 2020: A reality check
For a brief period at the start of 2020, market sentiment remained similar to that of 2019, 2017, and most of 2018 (before the aforementioned fourthquarter 2018 drawdown, with low volatility and limited, infrequent pullbacks. Then came the COVID-19 pandemic, which crushed investor confidence as government-mandated lockdowns effectively paralyzed the global economy. U.S. large-cap stocks (as represented by the S&P 500 Index) fell approximately 34% in the 23 trading days between February 20 and March 23. The quarter ended with a market drawdown that was larger than average (as measured by the S&P 500 Index, since March 1957, and its predecessor, the S&P 90 Index, since 1928), and the worst quarterly decline since the fourth quarter of 2008.
While notable, the magnitude of the drawdown in February and March of 2020 was not out of the ordinary. In fact, it was fairly in line with previous bear-market selloffs. This is illustrated in Exhibit 1 (download full commentary), which captures market drawdowns and yearly returns for the last fifty years.download the full commentary
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts.
There are risks involved with investing, including loss of principal. Diversification may not protect against market risk. There is no assurance the objectives discussed will be met. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments.
Past performance does not guarantee future results. Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company (SEI).