Corrections and volatility have always been the price that investors must pay in order to capture any long-term market returns. Amid recent volatility, many investors have started to worry about the prospect of losing their gains.
While the market has, historically, spent most of its time in an updraft, it’s important for investors to remember that downdrafts are also a common and routine part of the ride. Depending on how one slices the numbers, the market has historically been in a downdraft about 30% to 40% of the time.
Maintaining one’s composure as an investor is difficult during that 30% to 40%—after all, it’s uncomfortable not knowing whether a single-digit dip will turn into a double-digit bear market. But it’s crucially important when seeking to capture the full benefits of the long-term compounding that the market has historically provided.
Putting the recent dip into perspective
As of March 11, the S&P 500® Index had declined 9.3% from the all-time closing high it hit in mid-February.
To put that into perspective, since 1927, the S&P has spent more than half of the time trading at a level of 5% or more below a recent high, and more than a third of the time trading 10% or more below a recent high.1
Slicing things another way, the market has suffered a drop of 5% or more in 93% of calendar years since 1980, and has suffered a drop of 10% or more in 47% of those calendar years.2 And yet as the chart below shows, its average calendar-year return in that same period has been 13.3%. These kinds of pullbacks really are remarkably commonplace.
And yet the market has recovered from every one of those periods historically—sometimes slowly, but often quickly—and gone on to deliver strong long-term returns. Investing is a numbers game, but it is during drawdowns when our human reactions threaten to overrule our clear-headed rational plans.
To put the recent price action into perspective another way, you can barely even spot the recent dip on the chart below. Perhaps it feels worse than it is?
Behind the market action: An aging bull, plus evolving expectations
The bull market that began in October 2022 is nearing the median age of bull markets, which is 30 months. Personally, I’m not convinced it’s run its course (that median-age figure masks wide dispersion in the lengths of individual bull markets). But to understand where the market is now, let’s review the anatomy of a market cycle.
Bull markets are typically born when it seems like the news can’t get any worse. Markets are forward looking—meaning stock prices always reflect expectations about the future. Even if today’s news looks terrible, if investors believe tomorrow’s news will be slightly less bad, then stock prices may start to rise. At this stage the market is often going up even though profits, or earnings, are still going down, which means that rising price-earnings ratios (PEs) are driving the market. Typically 2 to 4 quarters later, profits start turning up. And as the bull market matures, earnings growth takes over as the primary market driver, with PE ratios starting to decline.
That’s where we are right now. Earnings growth is in the double digits, but because we’re getting into the later innings of the bull market, PE ratios have gotten a bit stretched, and the market is slightly more prone to wobbles.
At the same time, the market has been processing the impact of recent trade-policy shifts. While the prospect of new tariffs came up during campaign season, my sense is that the market was hoping that this might be a negotiating tactic, or that any implemented tariffs might be reversed quickly as negotiations unfolded. Now, however, it’s very hard for the market to ignore that tariffs are in fact happening.
Investors shouldn’t catastrophize the situation—and of course, any of these policies could be rolled back at any moment. But I believe this explains much of the recent market reaction.
An about-face of market leadership
Beneath the surface of the market’s recent stumbles, the “Magnificent 7” group of mega-cap growth stocks have seen an even bigger decline, falling almost 20% from the group’s all-time high in December.
This could turn out to be a mere blip, like the stumble the Mag 7 saw last summer. But it’s been interesting to see such a quick reshuffling of market leadership. The Mag 7 and small-cap stocks are leading to the downside.
To the upside, non-US markets have been outperforming—particularly Europe—fueled by geopolitics as well as the German election, leading to the prospect of a boost from fiscal spending as Europe beefs up its defense and infrastructure.
Reflecting on decades of studying the market
This month marks my 30th anniversary with Fidelity. Looking back, one thing I’ve learned is that every time I think it can’t get any crazier, it actually does.
And yet through all the market’s different cycles, crises, booms, and busts—every single time, no matter how scary it looked—the market did eventually recover and go on to new all-time highs. That’s why I’ve found it can be helpful to be a bit cold-blooded and maintain some detachment as an investor.
There’s no bulletproof portfolio that will protect against all risk. Rather, a better aim may be to craft a portfolio that’s well-suited to your goals, needs, risk tolerance, and time horizon. The market doesn’t go up in a straight line. So it’s important for investors to persevere, remain disciplined, not overreact, and follow their plan even when challenging market environments arise.
