Lately, the story about market volatility is the lack of volatility. In this episode, Jonathan Clements and Peter Mallouk discuss the likelihood of a market correction in the near future and why you shouldn’t panic. They also offer tips about what to do with excess cash and fully funding your employer retirement accounts.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education at Creative Planning in Overland Park, Kansas. With me is Peter Mallouk, President of the firm, and we are Down the Middle.
If actions speak louder than words, what’s most notable about today’s market is the amount of inaction. Even as share prices have climbed nicely this year, investors collectively remained remarkably calm, or so it seems based on market volatility. If you look at the closing prices for the S&P 500, the stock market hasn’t had a 5% pullback since early 2020. That’s more than 10 months, an unusually long time. On average over the past 75 years, we’ve had a decline of at least 5%, and often much larger, every seven months. Meanwhile, the VIX, often referred to as the “fear gauge” or the “fear index,” is at just a quarter of a level it was early last year during the initial weeks of the pandemic. So that raises the obvious question, Peter: To what do we attribute this market calmness?
Peter Mallouk: Well, I think you’ve got a couple things. I think one, you just have a lot of money that’s pouring into assets. And so, when you have very low interest rates coupled with the Fed putting $5 trillion one way or another into the economy, it goes and it buys things. And that’s really lifted the markets and a lot of other asset classes like real estate and a lot of speculative assets, too.
So, while we have a reason for it to happen, it’s not normal for there to be such modest volatility. So the way the stock market works over the very, very long run is it goes up, right? So we know that over a very, very long period of time, it goes up. In the short run it goes all over the place. So if we take a given 12-month period, the odds the stock market will be positive are about three in four. Pretty reasonable expectation it will be negative. You know, one in four is quite often. If you’re starting at Creative Planning today, the odds your portfolio could be negative a year from now are about one in four. You stretch that out over three years, your odds are better than nine out of 10 that the portfolio will be positive. You stretch it out even longer, odds go more and more in your favor.
But what we know as investors is along the way, there is a price to pay for stock and real estate investing, and that price is volatility. Meaning things go up and down along the way, sometimes very violently. And we just haven’t experienced that over the last year or so.
Jonathan: Which seems unusual, Peter, given that we view volatility, earlier you said, as an indicator of uncertainty. If people are really uncertain, then you see financial market prices jumping up and down. And right now you might say there’s a lot of uncertainty out there. We don’t know what the trajectory of inflation is. We don’t know how good corporate earnings are going to be and whether we’re going to continue on this rapid recovery. There’s talk in Washington of possible tax law changes. And of course, we have the pandemic and the Delta variant, and we’re not sure how all of that is going to play out. All that would suggest that we would have a volatile market. And yet, the market seems to be telling us something entirely different. Do you think, Peter, that people are just being more certain about the future, or is there something else going on? Is it simply all this liquidity that you were talking about?
Peter: Well, I think part of it’s liquidity. And I think part of it is, as Americans, we have this incredible ability to forget. That’s probably responsible for a lot of our really poor foreign policy decisions made across both administrations over decades is we just, we forget the past and how things work. And I think we see that in bear markets when investors assume things will never get better. And we see it in bull markets when people get complacent very quickly. So if you look at what normally happens in the stock market, volatility-wise, you and I have been talking about volatility and the VIX, which measures that. In a normal year, we expect a lot of ups and downs. In an average year, the stock market will drop from its high about 14% on average every year.
So, let’s just assume this happens this year. We have an average year and at some point that happens. That would be a drop of between 4,000 and 5,000 points. Everyone is going to lose their minds, right? When that happens, because it’s been so long since it’s happened. So we just got to get in this norm and people start to de-risk and they get overconfident. And you see that because people start to move. You don’t just see lack of volatility in the market, you see people take more risk for incrementally little reward in those parts of the cycle. And that’s where we are now. We’re seeing people take excessive risks to buy bonds that pay just a little bit more than conservative bonds.
And so, I think we’re due. I mean… we could go a year and I have no idea when it’s going to happen. And I never claim to know it. I think anytime any forecaster, any advisor, gives you a forecast with certainty, you should run as far in the other direction as you can from that advisor because no one knows what’s going to happen.
But what we do know is that the market doesn’t go straight up with no volatility. We know that, right? And so we know at some point we’re going to have a return to normalcy. And so I’m not predicting when it’s going to happen. I’m just saying it very likely is going to happen sometime in the next 12 months because that’s the norm. And we should be prepared to take advantage of it instead of being scared when that happens.