Investing In Volatile Markets

Investing In Volatile Markets

By Andrew Khosrofian, Assistant Vice President, Portfolio Manager & Analyst, Diamond Capital Management


It has been a stressful experience to open investment account statements in 2022. Since June, the S&P 500 (SPX) has been straddling a Bear Market, defined as a loss of at least 20% from a recent high. During these volatile and uncertain times, it is important for long-term investors to maintain a disciplined investment process. While there is a saying that “past performance is not indicative of future results,” data from past economic and market cycles can help guide investors how the market might react in different economic environments.
 
The most recent prolonged U.S. recession lasted from the beginning of 2008 through the end of June 2009. During those 18 months, the total return of the SPX was -35.01%, or -24.99% annualized. Coming out of the 2008-2009 recession, the SPX quickly gained 22% from July 2009 through the end of the year. While the SPX did not fully recover to its pre-recession price level of about $1,470 until January 2013, the SPX had a total return of 334.79% from July 2009 through December 2019, or about 15% annualized. If an investor sold off their market exposure in 2009, the investor would have missed the annual total returns for the next five years of the SPX of 15.06%, 2.11%, 14.06%, 34.09% and 15.74%, respectively. This simplistic demonstration of a market cycle emphasizes the importance of maintaining long-term investment plans to better achieve goals in times of volatile markets.
 
It is important to note that investing themes that were effective for the 10-12 years following the 2008-2009 recession may not necessarily be effective coming out of a potential recession in 2023. While the growth investing theme dominated the past decade, particularly with the rise in popularity of the FANG stocks – Facebook, Amazon, Netflix, Google, the next market cycle may be more favorable to value stocks. Value stocks are typically seen as being of high quality. These stocks tend to have low price-to-book ratios, low price-to-earnings ratios, and high dividend yields.
 
At The National Bank of Indianapolis, we believe value stocks should be emphasized during volatile times. Value stocks have historically experienced lower drawdowns over time than growth stocks. For example, despite the Covid-19 pandemic, the SPX returned 61.33% beginning March 1, 2020, through the end of 2021. ARKK, an actively managed growth ETF which invests in companies relevant to the theme of disruptive innovation, returned 83.47% during that same period. In comparison, the Dow Jones Select Dividend Index (DJDVY), composed almost entirely of attractive dividend paying stocks, returned 44.73%. Taking a longer view from March 1, 2020, to the end of Q3 2022, the SPX, ARKK, and DJDVY had total returns of 26.41%, -26.82%, and 30.16%, respectively. YTD, as of the end of the third quarter this year, the SPX was down 23.88%, ARKK down 60.11%, and the DJDVY was only down 10.07%.
 
Overall, these numbers provide an extreme case of upside and downside volatility of growth versus value stocks. However, renowned economists Eugene Fama and Kenneth French noted that stocks with high book-to-market equity ratios outperformed stocks with low book-to-market ratios in 12 of 13 major market cycles during the period of 1975-1995. Looking for opportunities, the Bear Market of 2022 thus far has caused material adjustments to the fundamentals of US stocks, creating more favorable valuations across the entire market. While the outsized upside returns of innovative, growth stocks can be tempting, the less volatile, more even returns of value stocks are likely more appropriate in volatile times to match the risk tolerance and investment goals of most long-term investors.
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