If asked to describe the last four years with just a single word, there may not be a better answer than volatile. And that applies, perhaps especially so, to the economy that corporate America — and, by extension, investors — have been forced to navigate. So this Sunday, we asked an expert to help us sift through the biggest trends and forces of these volatile past few years.
Photo illustration by Connor Lin / The Daily Upside, Photo via Vanguard
There was a pandemic, a financial crisis and recovery, a supply chain crisis, and the so-called retail apocalypse. War broke out and sparked a global energy crisis. Historic inflation paved the way for interest rate hikes. Bears and bulls ran amok through global markets while a swashbuckling band of retail investors toppled a hedge fund. Now there’s arguably the most consequential election in US history, there’s a trade war, there’s war, there’s interest rate cuts, and there’s another supply chain crisis on the horizon. And that’s not the half of it.
The last four years have been packed with a head-spinning, era-defining density of history that rivals some centuries. Keeping track of the resulting economic ripples, both seismic and subtle, would seem a daunting task but, for suburban Philly-based Vanguard, the investment management firm with over $9 trillion in global assets under management, it’s just another day at the office.
The Daily Upside asked Dan Newhall, the firm’s head of portfolio solutions, to talk us through what they’ve observed over the remarkable — and remarkably volatile — last four years. You may just be surprised to hear what presidential elections do to markets.
This interview has been edited for clarity and condensed for length.
TDU:Investors have been through what feels like several mini bear and bull market cycles since the beginning of the pandemic — is this level of volatility of performance, and even sentiment, the new normal?
DN: 2020 and 2022 were volatile years. We experienced a pandemic in 2020 unlike any in the past 100 years and in 2022 inflation led to a very poor year in the bond market. However, if you look at the volatility experienced in 2023 and so far into 2024 in comparison to the past three decades, it’s relatively low with fewer significant market drawdown days. [Editor’s Note: See illustration below.]
Investors should expect volatility and market pullbacks to occur, and, importantly, construct their portfolios to be resilient to a wide range of market environments.
TDU:While we may have experienced relatively low volatility so far in 2024, the upcoming presidential election is often billed as one of the most consequential in US history. Should we expect market volatility in next month and beyond?
DN: Vanguard research dating back to 1860 found no statistical relationship between the performance for a balanced portfolio in presidential election and non-election years — or for presidential terms.
Markets, by their very nature, price in current events. Stock market volatility leading up to and after a presidential election (100 days on either side) shows no statistical relationship. Analyzing all election years from 1984-2020, Vanguard research found the S&P’s 500 Index’s average annualized volatility was 16.5% in the 100 days before a presidential election, and 15.9% for the 100 days after the election — both of which were lower than the 17.9% annualized volatility during the full-time period. Of note, we did see volatility in the markets in 2000 and 2008, though it was related to market-wide events, not elections.
TDU: This year’s market movement has been driven in large part by just a handful of Big Tech firms. Should there be concerns about concentration risk, especially when it comes to potentially bubbly narratives like generative AI?
DN: Equity market returns and the weightings of the companies that generate such returns is highly skewed. Historically, a small handful of stocks drive a significant portion of stock market wealth accumulation; since 1926, half of the US total stock market return was generated from only 72 stocks. As such, historical market-wide returns look nothing like the typical stock return.
TDU: What about meme stocks? Since the pandemic, retail investors have actually become a force in certain public market scenarios, consolidating market-moving power. Has the rise of the meme stock movement created a new type of market volatility — and can investors capitalize on that volatility?
DN: We saw the meme stock frenzy play out in 2021, and through bouts of increased social media activity around companies like GameStop even earlier this year. This scenario has also played out in the past, such as during the day-trading message board era in the late 1990s or even further back in time as immortalized in “Reminiscences of a Stock Operator” written in 1923.
Our CIO Greg Davis said it best when he said it’s important for investors to not confuse speculation with investing. When stocks are rising, it can make day trading seem tempting. But, it’s a risky bet. In our view, there isn’t a way to secure long-term investment success through short-term speculation.
TDU: One of the big question marks all year has been when — and how often and by how much — the Federal Reserve cuts interest rates. It’s still unclear how many more rate cuts the Fed will deliver by the end of the year. How should investors prepare?
DN: Investors have recently benefited from the higher yields on money market funds, but yields have already begun to fall following the Fed’s September rate cut. However, while lower interest rates will be quickly reflected in lower yields on money market funds, bonds have the potential to offset declining income through capital appreciation and are back as an attractive asset class.
Looking ahead, our 10-year forecast for bond returns is competitive with US equities — with much less expected volatility. In 2021, the expected probability of experiencing negative bond total returns — when price losses exceed coupon payments — due to rising rates was 60%, whereas in 2024, that probability has fallen to 11%.
TDU: How should investors think about global diversification when constructing their portfolio, particularly as emerging markets can experience higher bouts of volatility?
DN: Being globally diversified and having international exposure to both emerging and developed markets can broaden an investors’ exposure across multiple asset classes, helping to reduce volatility over the long term.*
We believe investors stand to benefit from the strong diversification characteristics combined by investing in both US and international equities. There’s a saying out there that diversification is akin to a free lunch, and we couldn’t agree more.
Written by Sean Craig
Notes
*Notes to chart: Non-U.S. equities are represented by MSCI World ex USA Index and U.S. equities are represented by the MSCI USA Index from May 31, 1970, through December 31, 2023. Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment as you cannot invest directly in an index.
