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Prepare for more stock market turbulence, it’s normal

Top 1000: At the end of July, Japan’s Nikkei index was up 18 per cent in 2024 but was down 5 per cent on the year after just two days of trading in August

Global stock market volatility was perfectly illustrated by movement in share prices on the Nikkei in late July and early August

Recent coverage of August’s stock market volatility brought to mind that episode from The Simpsons where TV presenter Kent Brockman asks his expert guest: “Professor, without knowing precisely what the danger is, would you say it’s time for our viewers to crack each other’s heads open and feast on the goo inside?”

Things were certainly volatile in early August. At the end of July, Japan’s Nikkei index was up 18 per cent in 2024, but the same index was down 5 per cent on the year after just two days of trading in August. Wall Street’s fear index, the Vix, briefly hit its third-highest level in history, behind only the 2008 global financial crisis and March 2020′s Covid crash.

The coverage was predictably breathless in the tabloid press. Even among more sober outlets, however, the headlines often gave the impression all hell was breaking loose. “$6.4 trillion stock wipeout has traders fearing ‘great unwind’ is just starting”, headlined Bloomberg. The Guardian went with: “Share market chaos explained: what’s behind the stock meltdown and will there be a recession?”

As it happened, the S&P 500 took only four days to recover to levels seen before the apparent market crash. Indeed, even the word ‘crash’ seems questionable, given that August’s market low merely brought US indices back to levels seen in May.

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Some investors may have lost sight of just how good they had it. Prior to the downdraft, the S&P 500 was up 20 per cent in 2024. The index had not fallen by more than 2 per cent in a day since early 2023.

Stocks are not meant to go up in a straight line. Calling for perspective, Carson Group strategist Ryan Detrick tweeted: “Stocks go up 50 per cent from October 2022 and then we have a few bad days. It is like everyone forgets that is how it works.”

People living in Ireland don’t express stunned surprise if it rains in July, or if a storm hits the country in January. These things happen and are to be expected.

It’s the same with stock markets.

The point is that August’s volatility was not abnormal – occasional market turbulence is to be expected.

“Here’s the thing – it’s what happened before this that was not normal,” noted Ritholtz Wealth Management’s Ben Carlson. Prior to the downdraft, the S&P 500′s maximum peak-to-trough decline in 2024 was just 5.9 per cent. Historically, a double-digit correction happens in around two-thirds of all years. The average maximum drawdown in a given year is 16.3 per cent, says Carlson. In other words, the recent downturn – the S&P 500 fell 9.7 per cent – was actually quite mild.

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Declines should be expected in strong as well as in difficult market environments. Carlson notes the S&P 500 has advanced in 70 of the last 96 years. In 35 of those 70 years, the index experienced a double-digit correction along the way. Indeed, even years where the S&P 500 ultimately registered a strong double-digit advance, stocks suffered a double-digit loss at some point in the year almost half the time.

Carlson’s point: “The stock market goes down even when it goes up.”

Many investors will have read that stock markets have historically averaged annualised gains of around 9 to 10 per cent, but it’s important to know that ‘average’ returns are in fact quite rare.

Separate data from Carlson shows there have been only five years where the S&P 500 enjoyed gains of 8 to 12 per cent. Gains ranging from 5 to 15 per cent have occurred in less than one in five years

. You’re more likely to experience a double-digit loss in a given year than a return that is close to the long-term average, says Carlson. Note too that more than one-third of all years have seen gains of 20 per cent or more.

In short, market returns are lumpy. Stocks can swing about in wild fashion. This isn’t abnormal – it’s normal.

In short, market returns are lumpy. Stocks can swing about in wild fashion. This isn’t abnormal – it’s normal.

Making the case for calm during the 2008 global financial crisis, iconic investor Warren Buffett noted that in the 20th century, America had endured two world wars, the 1930s depression, as well as a flu epidemic, oil shocks, and “a dozen or so recessions and financial panics”. Nevertheless, the Dow Jones index rose from 66 to 11,497.

It should have been impossible for an investor to lose money during this prosperous century, said Buffett, but many did, selling when the headlines made them “queasy” in those all-too-regular periods of turbulence.

People living in Ireland don’t express stunned surprise if it rains in July, or if a storm hits the country in January. These things happen and are to be expected.

It’s the same with stock markets. Volatility and turbulence are par for the course and to be expected.

Stocks have historically delivered superior long-term returns, but volatility is the “price of admission”, as Morgan Housel puts it in his bestselling book, The Psychology of Money. If you don’t pay the price, you don’t get the prize of superior long-term returns.

Quite simply, volatility “is a feature” of stock markets, says Carlson, “not a bug”.

You can find more on Top 1000 here. For the full list of Ireland’s Top 1000 companies, sign up to the ePaper today. The full supplement is also available in Thursday’s (12/09/2024) print edition