Navigating Market Volatility
There has been no shortage of market-moving events to begin 2022. Russia’s unprovoked invasion of neighboring Ukraine and the associated humanitarian and economic implications have recently dominated headlines, emphasizing the importance of managing market volatility. At Madison, we have accounted for unforeseen market swings in market returns through Madison’s financial planning process and the well-diversified, risk-customized portfolios we build for our clients.
Through the first two months of the year, the S&P 500 is down 8%, with strong differentials in style performance; Large-cap value and growth are down 3.5% and 12.5%, respectively. We’ve also seen pressure in fixed-income markets. The Barclays Aggregate fell 3.1%, as interest rates have crept upward to start the year. 2022 has been a strong reversal from the stellar market returns of 2021.
The unrest in Europe is being priced into the markets as of the time of this writing. Global markets have reacted by depreciating the Russian ruble, spiking inflation in the region, while devaluing most Russian assets as crippling sanctions on Russia isolate the country from the global financial system. In our view, the downturn in global stocks has been fairly rational given the perceived and realized geopolitical risks. Our view on this is founded in data—Russia currently has a weight of less than 1.5% of the MSCI Emerging Market Index, and less than 0.40 % of the MSCI All Country World Index. While the country’s economic impact to the world might have knock-on effects given its main export to the world is oil, it’s a point that can’t be overstated in terms of its economic footprint. Russia’s GDP (gross domestic product) is about the same size as the State of Texas and when adjusted for purchasing power, makes up just over 3% of Global GDP. So, while it’s not without risk that Russia can impact markets far greater than its global economic importance, it’s much more constructive to take a longer-term view and recognize that markets tend to look through geopolitical events and climb higher over time, as evidenced above.
Current events force us to realize that volatility comes part and parcel with being invested in financial markets. In fact, just last year we had many instances where markets could have acted much more erratic, yet volatility was fairly benign relative to history. This month we wanted to revisit our fourth-quarter market review comments around this subject. In many ways 2021 was an anomaly given its steady, consistent trajectory upward, even in the face of the numerous headlines (picture below). In the face of geopolitical risks, a presidential impeachment, global supply chain disruptions, and rising inflation, the S&P 500 increased over 28%, emphasizing that investing on emotion or negative headlines can be detrimental to an investor’s long-term success.
We wrote in January:
“The worst intra-year decline the S&P 500 saw in 2021 was just 5%…historically, the S&P 500 declines about 14% from peak to trough each year. Another way to look at market volatility is the days in which the markets fell or advanced +/-2% or more in a single day. In 2021, the S&P 500 only had six days where markets rose or declined by over +/-2%. Since 2001, the average has been nineteen days.”
Today’s market movements may feel especially painful after being somewhat lulled into a sense of tranquility in 2021.
A war tends to swing us from calm to what seems like chaos. Amid times like these, our core investment philosophy of owning high-quality, globally-diversified assets is of the utmost importance. Therefore, we want to share one additional excerpt from our quarterly review.
“One thing we wouldn’t be surprised by is heightened volatility in both the equity and fixed income markets in the coming year as the Fed tries to get the economy back to some semblance of economic normalization. So now more than ever it’s vital to take a long-term perspective, keep balance across asset classes, and use volatility in financial markets to your advantage.”
As always, our Madison team is here to help answer any questions you may have.