The headlines have been volatile lately, leading to anxious calls from clients wondering if they should take action based on what they think might happen.
If you want to make some changes at the margin, that’s probably okay, but a wholesale change at this moment probably says more about your political views than an unbiased investment outlook.
When we set an asset allocation policy with clients, it’s usually in the context of a financial plan. At some point in the conversation, we always say, ‘you could lose ABC percent, which translates into XYZ dollars.’ When we do it with the software, the losses are in big, bold, red letters (or digits, as it were).
I usually say something like, “I don’t know when, and I don’t know why, but I promise it will happen” (if it never happens, most people will forget my promise, but it will happen). When we all agree that there will be bad times, I like to say something like, ‘And we’re going to hold on like grim death.’ We all laugh, and move on.
It’s far too early to give this speech (via email). After all, the S&P 500 is ‘only’ down six percent from its all-time high in February. Yes, that’s a quick loss, but it’s not even a correction (a decline of ten percent or more), and it’s in the context of a five-year time frame when the index more than doubled (even with the recent loss and the loss at the outset of the pandemic).
If we had bought the 2x Long Nvidia exchange-traded fund, which is down -38.0 percent this year, I’d be sweating bullets. But we’re just the opposite: other asset classes like international and emerging are helping stem the losses (not to mention bonds and an underweight to tech).
So why are some people bothered? I think it’s because volatility has jumped and we’ve become a little complacent.
The chart above shows the S&P 500’s 20-day rolling volatility in green (20 days is approximately a month, excluding weekends). The yellow is the one-year average.
Three years ago, when inflation was raging and the Federal Reserve quickly raised interest rates from zero to more than five percent, stocks and bonds sold off, and volatility was high.
Then, inflation moderated, stocks shot higher with two years in a row of 25-26 percent gains, and volatility fell to the floor. The average volatility since the end of the Great Depression is about 15 percent, which was 18 percent if you go back to 1926. In 2024, volatility was averaging close to ten percent.
Realized volatility jumped recently to over 15 percent, but that’s simply consistent with the long-term average. My first version of this chart went back five years, but since that included the pandemic, you could barely determine what happened recently because that was such an extreme period.
Naturally, I prefer low volatility periods, but I also know that when it gets too low, something will come along and raise it. And when it’s high, something will come along and bring it back down again. Without volatility, a proxy for risk, there wouldn’t be any returns above Treasury bills.
I have no idea where stocks will go from here, in the short or long run. The S&P 500 is expensive, so I think the returns will be less than the long-term average over the next decade, but I also think they will be more than Treasury bills. But who knows? I’ll stay invested in my diversified portfolio.
Try not to sweat the volatility, it’s normal, and part of the price of admission.
