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5 Lessons About Volatility to Learn From the History of Markets

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In 2018, the re-emergence of volatility took many market participants by surprise.

After all, aside from a few smaller, intermittent spikes over the course of the current bull market, volatility has largely been in a long-term downtrend since the aftermath of the 2008 Financial Crisis.

Whether there is more volatility lurking ahead this year or whether the markets continue to calm, it’s worth looking at the last century of market history to put these recent bouts of volatility into context.

Learning From the History of Markets

Today’s infographic comes to us from New York Life Investments and it goes back in time to show us that the volatility experienced in 2018 was neither exceptional or unusual.

Here are five important lessons to learn from it all:

5 Lessons About Volatility to Learn From the History of Markets

This infographic is available as a poster.

With volatility back on the table again, investors are re-learning what it’s like to cope with a sometimes tumultuous market.

Higher volatility can be a source of uncertainty for even the most seasoned investors, but a look at historical data over the last century helps to ease these concerns.

5 Lessons About Volatility

Here are five lessons about volatility that we can learn from the history of markets:

Lesson #1: Volatility isn’t new
Volatility isn’t a new phenomenon – and it’s actually as old as the stock market itself. In fact, if you look at historical swings in the Dow Jones Industrial Average, you’ll see that many of the biggest ones were more than 80 years ago.

Lesson #2: Volatility is actually the status quo
In the last century, volatility has been ever-present in the markets, and between 1935 and 2018 the S&P 500 has seen:

  • 4,563 total days with +/- 1% price movements
  • 1,094 total days with +/- 2% price movements

That works out roughly to a 1% price swing every trading week – and a 2% price swing every month. Yet, over this lengthy time period, and after all of that volatility, the S&P 500 has grown by 25,290%.

Lesson #3: Any short-term volatility disappears with a long-term view
Daily price swings can feel like a roller coaster. But if you take a step back and look at the big picture, this volatility is just a blip on the radar.

For example, if you look at a chart of the S&P 500 from August 1990 to February of 1991, you’ll see that daily volatility was rampant. But zoom out to a 10-year chart, and these daily or weekly swings are barely noticeable.

Lesson #4: Volatility can be easily weathered with a resilient portfolio
Given that volatility has been around forever and that it’s extremely common, that makes it fairly unavoidable. Therefore, to weather periods of volatility, it is imperative to build a resilient portfolio by diversifying between different asset classes.

Certain assets are better at weathering periods of volatility than others. Here are some traits to look for:

(a) Low correlation with the market
These assets can zig when others zag, making them a valuable hedge (Examples: Gold, alternative assets, municipal bonds)

(b) Generates cash flow
When times are uncertain, the market puts extra value on assets that are generating real cash flow (Examples: Stocks that pay dividends, or bonds that pay interest)

(c) Defensive or non-cyclical
During uncertain times, there are still companies with stocks that will thrive. They are usually bigger companies with conservative balance sheets and durable competitive advantages. (Examples: Quality stocks in healthcare, consumer staples, telecoms, REITs, and utilities sectors)

Lesson #5: Volatility reminds us that there is no reward without risk

Investing in stocks comes with risks, but it also comes with the best returns over time:

Asset TypeAnnualized real return, 1925-2014
U.S. Equities6.7%
Government Bonds2.6%
Cash0.5%

If stocks offer the best long run gains – and volatility is an unavoidable aspect of investing in stocks – then we must learn to accept volatility for what it is.

Even better, we must learn to build resilient portfolios that can weather any storm, while minimizing these effects.

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Infographics

Where Investors Put Their Money in 2019

Fund flows analysis is a useful tool for tracking where investors placed their investments. Let’s see what they were doing prior to the COVID-19 pandemic.

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This infographic is available as a poster.

Where Investors Put Their Money in 2019

While a strong 2019 closed off an entire decade free of recessions, celebrations have been short. The COVID-19 pandemic, which has tapped the brakes on the global economy, has led the International Monetary Fund (IMF) to declare a global recession.

So what were investors doing before the outbreak? To figure that out, today’s infographic from New York Life Investments visualizes where investors allocated their money in 2019.

Broad Comparisons

Virtually every asset class ended 2019 in the green, with U.S. equities among the highest gainers. In spite of this, investors appeared to be quite risk-averse. Even as the S&P 500 climbed 29% over the year, money was pulled away from equities and placed in safer assets such as money market securities and precious metals.

Let’s examine the data in more detail. In the tables below, net flows represents the difference between total inflows and total outflows.

Mutual Funds VS ETFs

Investors continued to invest in ETFs, but the interesting news is surrounding mutual fund activity. In a dramatic reversal from last year’s net outflows of $91B, mutual funds attracted $574B throughout 2019.

Type of Vehicle2018 Net Flows2018 Total Assets2019 Net Flows2019 Total Assets*
ETFs+$238B$3,385B+$281B$4,408B
Mutual Funds-$91B$16,345B+$574B$19,727B

*2019 total assets also include asset appreciation as a result of market movements.

ETFs once again grew their share of total invested assets, from 17.2% in 2018, to 18.3% in 2019.

Flows by Asset Class Group

To get more specific, investment vehicles are classified based on the type of assets they hold.

For example, a fund that holds a variety of American company stocks would be broadly classified as “U.S. Equity,” while a fund that targets specific industries would be classified as “Sector Equity.” Here are the flows each asset class experienced throughout 2019, starting with the largest net inflows:

Asset Class Group2019 Net Flows 2019 Total Assets 
Money Market+$522B$3,483B
Taxable Bonds+$413B$4,433B
Municipal Bonds+$106B$952B
International Equity+$11B$3,416B
Commodities+$8B$110B
Alternatives-$7B$212B
Sector Equity-$33B$995B
Asset Allocation-$38B$1,343B
U.S. Equity-$72B$9,162B

Investors pulled money from asset allocation funds, as well as alternatives, sector equity, and U.S. equity vehicles. Trade tensions between the U.S. and China, which have had a material impact on both countries’ economies, may have been a reason for this conservatism. Other likely factors include the Hong Kong protests and the culmination of Brexit.

In the face of these worrying developments, fixed income vehicles were in high demand, even as the Fed cut rates on three separate occasions. Money market funds had a massive year, and were responsible for much of the investor capital diverted to mutual funds in 2019.

In fact, with a Q3 net inflow of $224B, money market funds saw their strongest quarterly inflows since the global financial crisis.

Deeper Dive: Commodities

One of the most compelling flow trends of 2019 lies in commodities, which we can break down into five subcategories:

Commodities Subcategory2019 Net Flows 
Precious Metals+$11.4B
Industrial Metals-$0.1B
Energy-$0.2B
Broad Basket-$0.8B
Agriculture-$2.2B

Precious metals, which include safe-haven assets like gold and silver, were the only subcategory to see positive net flows in 2019. Likely driven by the fear of inflation, investors flocked to precious metals from June to October.

Gold and silver are often referred to as “safe-haven” assets because they outperform during periods of uncertainty.

The Motley Fool

It’s interesting to note that investors pulled money out of precious metals in November and December—perhaps a sign of growing confidence in the economy.

2020 and Beyond

Due to the ongoing COVID-19 pandemic, volatility has returned to global markets.

While the conservative asset allocation decisions made in 2019 may have given investors some shelter from this turmoil, it’s likely they paid a penalty for missing out on a robust year for equity markets.

In uncertain times like these, it’s important for every long-term investor to keep a cool head. After all, history has shown us that markets will eventually recover.

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Infographics

How a U.S. Election Could Impact Your Long-Term Investment Goals

Many factors are threatening retirement savings, and a U.S. election could mean more volatility. See how elections have historically affected investments.

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U.S. election performance

This infographic is available as a poster.

How a U.S. Election Could Impact Your Investment Goals

When constructing a financial plan, it can seem like there are a million things to consider. Your life expectancy, the return needed to reach your goals, and your risk tolerance all play a role. In addition, short-term events like the U.S. election can influence the volatility in your portfolio.

In today’s infographic from New York Life Investments, we outline the factors threatening individuals’ retirement savings, and how a U.S. election has historically impacted investments.

A Precarious Future

In recent years, a variety of factors have increased longevity risk—the possibility that individuals will outlive their retirement savings.

Little Savings, Low Yields
A quarter of working Americans have no retirement savings, and 44% feel their savings are not on track.

What’s more, investors now face a low yield environment, affecting their ability to save. From its peak of over 15% in the early 1980s, the U.S. 10 Year Treasury Yield now sits below 2%.

Longer Lives, and More Retirees
With a higher life expectancy today than in previous generations, Americans need to save for a longer retirement. What’s more, the aging U.S. population will peak within the next few years—creating even more urgency.

At the other end of the working life scale, millennials will make up 75% of the global workforce by 2025. To avoid the same issues as baby boomers, they will need to set a strong retirement savings foundation from the start.

Layered Uncertainty
In 2020, the uncertainty of the U.S. election further complicates these longevity issues. With the political divide growing, heated opinions have dominated headlines—and many experts are predicting market volatility.

U.S. Elections and Market Performance

However, volatility doesn’t necessarily mean poor performance. In fact, it has generally translated to positive returns in election years. In the 23 election years since 1928, only four years have seen negative returns.

S&P 500 Stock Market Returns During Election Years

YearReturn
192843.6%
1932-8.2%
193633.9%
1940-9.8%
194419.7%
19485.5%
195218.4%
19566.6%
19600.5%
196416.5%
196811.1%
197219.0%
197623.8%
198032.4%
19846.3%
198816.8%
19927.6%
199623.0%
2000-9.1%
200410.9%
2008-37.0%
201216.0%
201611.9%
The average return during these years was 11.3%.

Sector Performance

An incoming administration’s policies have the potential to sway market segments and sector returns. For instance, sector dispersion increased substantially around the 2016 election.

Which sectors have done well historically?

From the beginning of the 2008 election year to the end of the Obama administration, the S&P 500 Health Care Index increased by 103%, compared to the 55% increase in the S&P 500 Index over the same period. It is possible that Obama’s pro-health policies contributed to the sector’s growth.

From January 2016 to January 2020, the S&P 500 Aerospace and Defense Select Industry Index increased by 143% compared to the 72% increase in the S&P 500 over the same period. The Trump administration has increased defense budgets and deals, which may have contributed to the sector’s strong returns.

What About Bonds?

Historically, bond returns tend to be lower than stocks—and election years are no different.

Bond and Stock Returns During Election Years

YearU.S. Aggregate Bond*S&P 500Difference
19802.71%32.50%-29.79%
198415.15%6.27%8.88%
19887.89%16.61%-8.72%
19927.40%7.62%-0.22%
19963.64%22.96%-19.32%
200011.63%-9.11%20.74%
20044.34%10.88%-6.54%
20085.24%-37.00%42.24%
20124.22%16.00%-11.78%
20162.65%12.00%-9.35%

*U.S. Aggregate Bonds represented by the Bloomberg Barclays U.S. Aggregate Bond Index.

During these years, the median average annual return for bonds was 4.79% compared to 11.44% for stocks. Bonds have provided important diversification and risk management during market downturns. However, upside returns are generally more limited.

Reaching Investment Goals

While historical performance helps us understand the big picture, returns during the 2020 election could vary widely.

Instead of trying to time the market, Americans can keep a long-term focus and, if suitable, consider investing more heavily in equities—a powerful option in the current low rate environment. This may help investors manage longevity risk, and potentially build a sufficient nest egg for retirement.

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