Reset Your Expectations

The world has been on a tremendous journey over the past eighteen months, with the effects of the coronavirus pandemic touching nearly every facet of our everyday lives. Yet, despite the volatility, investors who stayed committed to a well-designed financial and investment plan through last spring did not see their portfolios get turned upside down. After the initial dramatic drop in the previous spring, investors have enjoyed nearly a year and a half of uninterrupted market gains.

Since the S&P 500 bottomed on March 23, 2020, the index has more than doubled. It took only about four months for the market to recover from the losses it experienced in February and March 2020 – a recovery magnitudes faster than any other significant market decline in history. Through August, the year-to-date return for the S&P 500 was over 22%. The Dow Jones Industrial Average, perhaps a more common metric, is up almost 17%. These returns have already surpassed many experts' predictions for all of 2021. And, they are not showing any signs of slowing down.

It is easy for the speed and intensity of the recovery to make investors feel complacent. Some might even begin to expect such strong returns every year. However, understanding just how unique this period has been is an important lesson to learn when properly setting expectations for the future.

Neither the Dow Jones nor the S&P 500 have experienced a pullback greater than 5% since October 2020, when a brief bout of volatility interrupted the markets' post-Covid rebound. This is the longest sustained upward movement since June 2016 through February 2018. But it's not just a lack of large declines that makes this market abnormal. Strong rebounds followed even smaller market declines.

For instance, on July 19, the S&P 500 fell by 1.6%. However, that day's closing price was a mere 2.9% off the record close from earlier that week, and the market immediately reversed course and went up five straight days until it reached a new record high. In fact, through the end of August, the S&P 500 has closed at an all-time high 53 times this year, the most ever for the first eight months of a year.

But what does all this mean to you as an investor? In the past fifty years, there have only been three years in which the market did not experience a 5% pullback. Therefore, investors should keep in mind that the market does not usually go up in a straight line and should mentally prepare for what a return to normal volatility would mean.

Given the large increases in the market, a normal pullback may alarm some investors because of how large it will be in absolute terms. For example, the Dow Jones finished the month of August with a value of 35,361. That means a drop of merely 1% would result in a decline of over 353 points. A decline of 1,000 points would only take a market decline of 2.8%--which, while meaningful, is certainly not abnormal. Gone are the days when a triple-digit decline in the Dow was noteworthy!

Stocks inevitably encounter rough patches and periods of increased volatility. While investors have benefited from seven straight months of increases in the equity markets, it is important to remember the cyclical nature of markets. Any number of variables could potentially reign in this rally—and they can occur without warning. We know that clients get sick of hearing us talk about the importance of having a solid investment plan, but we firmly believe in its importance. It may not seem too important when the markets only go up, but that won't last forever, and you are much better off having a plan before markets go bad on you.

If you would like to know more about how we have prepared portfolios for future market volatility, please reach out, and we would be happy to discuss in more detail.

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