PGIM: A Constructive Look At Market Volatility

2019 began on a high note, with the S&P 500 retracing its fourth-quarter loss. As the year rolled on, markets grew choppier with rising investor weariness around weakness in corporate earnings growth, but equities resumed their ascent on the back of the Fed’s dovish pivot, a decent earnings season, and stronger-than-expected economic data. Unfortunately, rising trade uncertainty led to more volatility in May, with the S&P 500 dropping nearly 7% in the month and the 10-year Treasury yield falling to 2.1%.¹ However, June kicked off with markets rallying from Fed chairman Powell’s statement that the Fed “will act as appropriate to sustain the expansion.” Still trade and global growth uncertainties continue to pose risks that may have markets in for a bumpy ride in the months ahead.

While it may be difficult to remain calm during turbulent market declines such as those experienced recently, it is important to remember that volatility is a normal part of investing. For long-term investors, reacting emotionally to volatile markets may have more of a detrimental impact on portfolio performance than the drawdown itself.

Market volatility can create opportunities

While recent market declines and the spike in volatility are unsettling, it may help to put short-term volatility into a longer-term context. Since 1946, pullbacks, which are defined as a 5%–10% decline, have occurred, on average, once per year, while corrections, defined as a 10%–20% decline, have occurred, on average, once every three years. As shown below, volatility may bring opportunity, as years with large drawdowns often end in positive returns. In fact, the S&P 500 finished the year positive in 74% of calendar years since 1980.

Years with large drawdowns often end in positive returns

Source: Bloomberg as of 3/31/19.

Stay calm, stay focused

Everyone wants to “buy low” and “sell high,” but most investors get caught up in the heat of the moment during volatile times and end up doing just the opposite. Timing the market is risky business, and the average investor rarely gets it right. When investors time their decisions poorly, their returns suffer as a substantial proportion of the total return of stocks over long periods tends to come from just a handful of days. Missing these days can have a significant adverse impact on total portfolio performance as show in the chart below.

Missing the best days can be costly

$10,000 invested in the S&P 500 (January 1999 – December 2018)

Source: Morningstar, PGIM Investments as of 12/31/18. This example is for illustrative purposes only and is not indicative of the performance of any investment. It does not reflect the impact of taxes, management fees, or sales charges.

 Effects of missing the best market days

Instead of panicking in a falling market, consider the longer-term implications and whether the current tumble can serve as a good buying opportunity. After a significant market decline, investors may find that stocks are undervalued, enabling them to invest in high-quality companies at a lower price. Remembering the long-term goal and sticking to a well-strategized, long-term investment plan can make it easier to stay calm and not overreact during periods of short-term volatility.