2016 has been a wild ride for stock market investors. The year was heavily peppered with frightening bouts of volatility.
The S&P 500 (^GSPC) kicked things off by falling 8% over its first 10 trading days, its worst first 10 trading days in history. After its first 28 trading days, the index was down a little over 10%, again marking its worst start in history.
The panic was palpable. One major Wall Street firm even urged clients to “sell everything.”
And yet, the market is now on track to close the year up around 10%.
Amid the noise, some veteran finance professionals offered some level-headed wisdom as the year unfolded.
“Volatility is not risk, it is the source of future returns.” – Jan. 10, 2016
January and February were painful for investors who were long the stock market. Fears over China’s economy — the world’s second largest economy — dominated the headlines. There was also volatility in oil prices, which exacerbated pain in the high yield bond market. Furthermore, the world was just coming off of the Fed’s rate hike in December 2015, the first such hike since June 2006. All of this stoked fears that the US economy was topping out and approaching a recession. And if you looked hard enough, you could find even more reasons why stocks were being volatile.
However, there was little to suggest we were on the brink of the next market-crashing financial crisis. Sure, it could’ve been the beginning of bear market. But after that initial selling, some seasoned experts told clients that this was a buying opportunity.
“Volatility is not risk, it is the source of future returns,” Ritholtz Wealth Management’s Josh Brown said in January. “Drawdowns should be embraced, not fled from. If anything, a better timing tool would be to up one’s allocation in times like these, or to skew one’s elections further toward equities to take advantage of a temporary decline. This is a passive way to exploit events that are beyond our control, and there is the added benefit that it actually works.”
Brown nailed it. A handful of other experts also advised clients to buy the dip. All of this proved to be lucrative advice for investors willing to stomach the volatility.
Markets tumbled for a couple more weeks. And on February 11, the market bottomed for the year. This whole exercise proved to be a lesson in the truth about the stock market.
“It’s always something.” – Apr. 1, 2016
And so the bull market resumed in what appeared to be a persistently uncertain investment environment.
In an April research note to clients, Bank of America Merrill Lynch economist Ethan Harris argued that fears over China were fading and that the volatility in oil prices was subsiding. But he also acknowledged that there were risks looming like Britain’s upcoming vote to exit the European Union, and the US presidential election, which came with bearish anti-trade rhetoric from both parties.
“It’s always something,” Harris said.
Indeed, you can “always” find risks or reasons to avoid investing in risk assets. But that has “always” been the case. And in the long history of the stock market, stocks and the companies underlying them have always figured out ways to grow profits in the long run. And that profit growth has fueled stock prices all along the way.
“The best investment decisions are ‘uncomfortable.'” – Jun. 10, 2016
Volatility seeped back into the markets mid-year as Britain’s so-called Brexit vote neared. While the polls signaled status quo, the polls were nevertheless close.
The S&P was trading at around 2,100 when Fundstrat Global’s Tom Lee shared some wisdom with his clients.
“One of the lessons I learned over the past 24 years as a research analyst (first job was Kidder Peabody), is the best investment decisions are ‘uncomfortable,’” Lee wrote. “We all know the entry point to go long, after steep declines, is never obvious. Upside breakouts are not any different.”
At this point, the stock market had recovered all of its losses from earlier in the year. As such, it seemed like a good opportunity to get out (especially for those who regretted not selling before the January sell-off).
Despite all of the unnerving risks dominating the headlines, Lee advised clients to focus on the fundamentals, which were telling him that stocks were still heading up.
“Nobody ever said it had to make sense.” – Aug. 2, 2016
On June 24, Brits shocked the world by unexpectedly voting to leave the European Union. It was an almost unthinkable event that sent financial markets around the world nosediving in its wake. Uncertainty was high, and stock prices fell. Perhaps the only thing that brought investors comfort was that the market appeared to be acting rationally.
But then something funny happened: After a couple of days, the markets recovered all of their losses.
“We have never had so many client meetings starting with statements such as ‘we are totally lost’,” Credit Suisse’s Andrew Garthwaite said in a July note to clients.
This was a big wakeup call for those who thought they got it right when they correctly guessed the outcome of the Brexit vote and prepared for the subsequent sell-off.
At least in the short run, the stock market doesn’t always move in the direction of its fundamental drivers. Indeed, that’s why they say “the market can stay irrational longer than you can stay solvent.”
“Nobody ever said it had to make sense,” Gluskin Sheff’s David Rosenberg said.
“Sometimes the market interprets everything positively, and sometimes it interprets everything negatively.” – Nov. 11, 2016
Like the Brexit vote, the US election results were unexpected. Like the Brexit vote, the US election results were followed by a violent market sell-off.
And then not long after, the stock market came back and then some.
“While people search the market’s behavior for logic, there really doesn’t have to be any,” Oaktree Capital’s Howard Marks said in a November memo. “I mentioned that sometimes the market interprets everything positively, and sometimes it interprets everything negatively. The market often fails to act rationally in the short run, primarily because of the role played by people in determining its course.”
Not only will markets not do what is expected. Rather, sometimes markets will do the total opposite of what is expected. And so, Marks left us with a truly unsettling set of takeaways.
“Thus two key observations can be made based on last week’s developments: First, no one really knows what events are going to transpire. And second, no one knows what the market’s reaction to those events will be.”
Let’s get one thing straight: none of this discussion is meant to be a congratulations for folks who stayed long and made money this year. Who’s to say the market won’t crash tomorrow?
The takeaway here is that bad news and uncertainty is just a normal part of investing. And investing is made that much more challenging as markets will behave irrationally in the short run. But those capable of stomaching volatility and seeing past bad news have historically been rewarded with gains. For more on all that, reread Warren Buffett’s op-ed he wrote after one of history’s worst sell-offs.
–
Sam Ro is managing editor at Yahoo Finance.
Read more:
