The new year is already shaping up to be far more volatile than 2021. Less than a month into 2022 we’ve already experienced a significant sell-off in many markets around the globe. Concerns regarding inflation, rising interest rates, and the prospect of central banks withdrawing quantitative easing this year have sent shockwaves through markets. At one point this week, both the New Zealand and US markets were down more than 10% from their peaks, while the tech-heavy Nasdaq Composite is still down over 15%. In some more speculative parts of the market, the action has been even more abrupt. The ARK Innovation ETF, which comprises high growth ‘story stocks’ in hot areas like electric vehicles, genomics and fintech, has fallen 22% this year – a massive 54% down from its all-time highs. Those tempted by Bitcoin are also suffering, with the cryptocurrency down nearly 50% from its highs.
This sort of market environment can cause a spike in investor concern – particularly for those that are newer to markets. However, it is always important to put market volatility in context and recognise the richer set of investment opportunities that are offered up in market corrections. Learning to embrace volatility can prove highly profitable over the long term.
Volatility is a natural function of markets, and is what creates opportunities for investors
Over the long-term the share market has delivered great outcomes for investors. The New Zealand share market has delivered a return of 9.9% per annum since the NZX 50 Gross Index was created in early 2001. Over the last 100 years the US S&P 500 Index has delivered a return of 9.6% per annum including dividends. Over the long term we still expect the share market to deliver good returns – particularly relative to those on offer at the bank.
But markets don’t go up in a straight line and there are often hiccups along the way. The table below shows just how regularly the market suffers setbacks. You should expect a 5% fall in markets roughly every 9 months, a 10-19% correction every 24 months, and a 20% plus decline (a bear market) about once every 7 years. Note, we have used the US share market here because there is better long-term data available.
How regularly does the share market plunge?
5% market decline
10% market correction
20%+ bear market
The chart below also provides a great way to visualise this. Since 1990, the US S&P 500 Index has delivered an average return to investors of 10.4% per annum. But as you can see from the blue bars on this chart, this performance resulted from many years when performance was higher than 10%, a few years when performance was between 0% and 10%, and a handful of years when share markets declined.
More importantly however, are the red dots on the chart. These show the ‘maximum drawdown’ from the markets peak in any given year. As we can see, there are very few years when the market hasn’t suffered a 5%+ decline. There are also plenty of times when markets have suffered a 10%, or even 20%+ decline.
Share markets aren’t often as smooth sailing as they were in 2021. But despite the bumps along the way, the market has still delivered great returns over the long term. The cost of the better returns available in equity markets is enduring the volatility along the way. If you have the temperament for it, the payoff is significant. $10,000 invested in the US market back in 1990 would now be worth over $260,000.