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Correction Reflection

Volatility is common in even great bull market years. Expect more of both in 2014. Now, volatility doesn’t always and everywhere mean “negativity”—positivity can be equally

Volatility is common in even great bull market years. Expect more of both in 2014.

Now, volatility doesn’t always and everywhere mean “negativity”—positivity can be equally volatile. But in my opinion, it’s healthy to think of negative volatility as the cost of doing business for an equity investor. A stock market devoid of volatility would likely yield lower returns—after all, if someone is pitching you an investment with high returns and no volatility, they’re likely either demonstrating how little they comprehend about investing, or they’re a shyster. So take the volatility. Live with it … embrace it … love it. (OK, maybe love it is going too far.)

Negative volatility can be very uncomfortable. And it can mean many things to many people. It may mean wider average daily swings in price to one investor. To some, it might mean a correction—a sentiment-driven, short and sharp negative move of 10% or greater. Still another investor may take it to mean returns are clustered in bunches and bursts.

However you interpret volatility, 2013 was probably an abnormally placid year. The S&P 500 Price Index’s average and median daily percentage movements (up or down) in 2013 were 0.59% and 0.41%, respectively. There were only 39 days of greater than 1% up or down movements, or one every 5.8 trading sessions. And the majority of 2013’s daily 1% moves were positive—22 up days versus 17 down. Only four days exceeded 2% price movement, equally split between up and down. There was no correction and only one cumulative short-term weak spot totaling more than 5% down. Meanwhile, stocks in the US and globally were up big. For most investors, a dream year!

This is a pretty stark contrast with the much more trying early years of this bull market. Since March 9, 2009, the S&P 500 swung up or down an average 0.80% daily. In total, 351 days exceeded 1% up or down, or one roughly every 3.5 trading sessions. The S&P 500’s daily movement exceeded 2% up or down on 103 days. Between March 9, 2009 and December 31, 2013, stocks suffered declines of 5% or more 13 times. 13! (Exhibit 1—yellow shading indicates decline of 5% or greater.) Since the bull began, the S&P has had four full blown corrections plus a fifth that reached -10% globally, but only -8% in the S&P 500.

Exhibit 1: S&P 500 Periods of Negativity Exceeding 5% Cumulative

Source: Global Financial Data, Inc., as of 01/14/2014. S&P 500 Price Returns for the period 03/09/2009 – 12/31/2013.

Corrections, caused by sentiment and not fundamentals, tend to be fleeting. There is generally a fear-inducing story nearly every investor is preoccupied with. Think 2010 and the Greek default tale. The S&P 500 fell 16% from May through July, only to snap back strongly and finish the year in solidly positive territory and above pre-correction levels. A volatile trip! Similarly, 2011’s and 2012’s corrections didn’t stop the bull. Corrections can be refreshers—keeping sentiment in check or convincing some bears their fear du jour has been addressed by market action.

Corrections are a healthy feature of a bull market. And being sentiment-driven, they aren’t something we believe can be repeatedly forecast. There is no one—no one—we’re aware of with a consistent and publicly documented history of timing corrections. And remember: Whether you get the beginning right is only half the equation! To successfully navigate a correction requires an equity investor to buy back in at some later, lower point. Usually, lower market levels and levels of fear are negatively correlated. The further a correction goes down, the bigger the fear-laden headlines. That likely makes many investors wary of buying back in.

There are times when taking a defensive posture is a rational, sensible step. But it isn’t just because you anticipate a correction might come. Since 2013, we’ve seen abnormally low volatility. It’s reasonable to expect more. More bull market, too—it’s just that not all years will be as smooth as ’13.  

By Todd Bliman
Fisher Investments

This constitutes the views, opinions and commentary of the author as of January 2014 and should not be regarded as personal investment advice. No assurances are made the author will continue to hold these views, which may change at any time without notice. No assurances are made regarding the accuracy of any forecast made. Past performance is no guarantee of future results. Investing in stock markets involves the risk of loss.

Source: FactSet, S&P 500 Price Returns from 12/31/2012 – 12/31/2013.
Source: FactSet. S&P 500 Price Returns from 12/31/2008 – 12/31/2013. Identified S&P 500 Index corrections were: 04/26/2010 – 07/02/2010; 05/02/2011 – 10/03/2011; 10/31/2011 – 11/25/2011; 04/02/2012 – 06/04/2012.
Global correction referred to is the period 01/14/2010 – 02/08/2010 as measured by the MSCI World Price Index. 
Source: FactSet, S&P 500 Price Return from 04/26/2010 – 07/02/2010.
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