Volatility, Risk & Stocks

My daughter is a great traveler. She’s almost six years old and she loves visiting new places. But she has one Achilles Heel when it comes to travel: She gets sick driving on winding, hilly roads.She routinely warns us in the car if the going is getting a little too rough: “Not too many hills and zig-zags, mom. I don’t want to get sick.” Luckily we live in Texas, and 95% of the places we go in a car are reachable via nice, straight roads.Unfortunately for investors, those percentages are almost exactly reversed when it comes to ups and downs in the market. Volatility is the norm, and the straightaway highway of stable growth is the exception.This is really important to keep in mind. It's easy to be optimistic about stocks during an unprecedented stretch of steady growth, like what we saw from October 2016 through January 2018. Everybody loves taking the stock market escalator up, and almost no one likes taking the elevator down. But the fact is, you need to be able to tolerate the elevator drop in order to be there when the next escalator starts climbing.Let’s illustrate just how unusual that 16-month stretch of steady growth was, from late 2016 to early 2018. Here is a chart of the S&P500 for the last five years:Source: MacrotrendsNow let’s focus on the stretch representing October 2016 to January 2018, in the top right corner, where the line smooths out:Source: MacrotrendsThis sections looks noticeably different than the rest of the line. If we focus on the opposite side of the graph on the left, covering February 2013 through September 2016, we see more spikes, indicating short-term volatility.Source: MacrotrendsAnd if we go back further in time, we’ll get an even better idea of how unusually smooth the last 16 months have been. The following graph shows the S&P500 going back to February 1998. Here, we can really see how those short-term spikes have been the norm for the last 20 years, up until late 2016.Source: MacrotrendsNow, is February’s return to volatility here to stay? Some say yes, and some say no, but most analysts agree that this was a correction and not the beginning of a larger crash or recession. As I wrote in January, reviewing corporate earnings is a great way to gauge the direction of the markets, and earnings still look strong.So, remember: Volatility is normal. Things might smooth out again, or they may stay bumpy for a while. If 2018 sees the return of prolonged market volatility, we’ll just have to re-learn how to ride it out and view the “elevator drops” as great buying opportunities.Happy investing!