Market volatility 2022: key factors and historic comparisons
January was a difficult month for world markets. What is driving the current volatility, and what can we learn from past periods of uncertainty?
Stock market corrections are social phenomena, where external economic events combine with crowd behaviour and instinctive fear. Selling by some market participants drives more market participants to sell, leading to a downward spiral in price. But markets tend to recover, and for those with a long-term investment time horizon perseverance can prove beneficial.
Global equity markets fell 8% in January*. This headline figure masks some larger declines, with “growth” sectors like technology having underperformed “value” sectors including energy and financials by around 10% on average. What’s triggered investor anxiety?
Stimulus measures from central banks and high levels of fiscal spending have provided a safety net for risk assets since March 2020. However, investors are now anticipating a very different environment, with higher interest rates, shrinking central bank balance sheets and declining support from government spending. Bond markets are now pricing in four interest rate hikes this year in the US and UK.
If inflation remains at elevated levels, the Federal Reserve and other developed market central banks could be forced to raise interest rates to the extent that it constrains economic growth. Secondly, higher interest rates could result in greater headwinds for “growth” sectors which have tended to benefit from both excess liquidity and low interest rates, allowing them to borrow cheaply to invest for future growth.
Given these concerns, and the rich valuation of many growth companies, we have seen a re-pricing of risk and expected returns – particularly for higher risk areas of the market. They have underperformed on a relative basis this year, after a period of very strong performance.
The Omicron variant is another worry for markets. In many countries, Omicron cases continue to rise and restrictions are being re-introduced. Economic activity indicators have already weakened as a result. While the experience of South Africa and the UK suggests this could be short-lived, Omicron has increased the uncertainty about global growth, further dampening investor sentiment.
Potential conflict between Russia and Ukraine is also a source of concern. Tensions have been escalating and the probability of military conflict rising. Russia has been warned of “unprecedented sanctions” from Western nations if it invades Ukraine. We could see even higher European gas prices if Russia limits supply in retaliation, exacerbating inflationary pressures.
The historic view: shorter-term falls are commonplace
Looking at intra-year declines, we can see that market volatility is a normal part of investing. The chart below sets out calendar year returns and intra-year declines for the UK equity market from 1986 to 2021. Despite average intra-year drops of 15.5% annual returns are positive in 25 of 36 years.
Source: FTSE, Refinitiv Datastream, J.P Morgan Asset Management. Returns shown are price returns in GBP. Intra-year decline refers to the largest market fall from peak to trough within the calendar year. Returns shown are calendar years from 1986 to 2021. Past performance is not a reliable indicator of current and future results.
This pattern is borne out when we look at other markets and longer timescales. If we look at the data in the US going back to 1928, the average drawdown over this period is -16.5%, with the market seeing double-digit drawdowns in two-thirds of all years.
Source: Bloomberg, S&P 500 in USD. Intra-year decline refers to the largest market fall from peak to trough within the calendar year. Returns shown are calendar years from 1928 to 2021. Past performance is not a reliable indicator of current and future results.
However, the data also shows that when there has been a correction of 10% or worse, three out of every five years have ended with a positive return whilst two out of every five years have experienced a double-digit correction but still finished the year with double-digit gains. So far this year the peak to trough decline is 9.3%.
The Covid crash in 2020 is an extreme example. For all of the turmoil that year, including the fastest ever “bear market” and the fastest subsequent recovery in 40 years, 2020 proved a good year for equities despite seeing a 34% correction in February and March 2020. The market still finished the year with an 18% gain. This was thanks in large part to the swift interventions from central banks and governments following the onset of the pandemic, as well as the promising vaccine news that arrived in November.
How often do stock market crises occur?
Looking back at the UK equity market returns over the last 50 years, we can see a number of eye-watering market falls including the 2020 Covid sell-off.
Equities peaked in May 1972 with a capital value of 228. By the end of 1974 the market stood at 62, a 73% decline in capital value. It took just under two years for the capital fall, and nearly four years for markets to rebound.
The “dot com boom” market peaked in September 2000 and then fell 51% over the next two and a half years, bottoming in March 2003. Again, it took nearly four years for the market to recover to previous levels. The credit crisis prompted a fall of 50% in equities between June 2007 and March 2009. The market eventually regained previous levels in May 2013.
These three dramatic falls had an average decline of 57%, taking an average of just over two years for the fall and four years for the recovery.
Trying to time your way into and out of markets could reduce the chances of protecting your assets from inflation, which, for most charity investors, is more of a threat to long-term sustainability than short-term volatility.
In the long run, investors are rewarded for taking risk. Avoiding risk entirely means avoiding returns – and the best days for market returns often come directly after the worst. Market timing is unlikely to add value.
What we have seen so far this year is nothing new and downside market volatility is perfectly normal. Market falls can periodically turn into a crisis, but history suggests that resisting the urge to rush for the exit can reap long-term rewards, and that volatility can provide opportunities for long-term investors.
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*Source: MSCI World YTD (close 27/1/22). Refinitiv
When investing your capital is at risk.
Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested.
This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.
All data contained within this document is sourced from Cazenove Capital unless otherwise stated.