When somebody complains about the weather in Kansas, you often hear the retort, “wait a few minutes and it will change.” Sometimes that change is positive, sometimes it is negative. In the short term, it is unpredictable, but in the long term the cycles of the seasons are highly predictable. Spring follows Winter, Summer follows Spring then Fall and Winter again.
Markets are no different. After a great year for almost all asset classes in 2021, this year has gotten off to a rocky start. Some of the volatility is not surprising since we anticipated that the Federal Reserve would be raising interest rates this year.
However, the Russian invasion of the Ukraine has added additional volatility. With global supply chains already stretched thin by Covid, these new disruptions have increased the threat of significant inflation. We are seeing these incremental stresses in the price of oil and gas, as well as commodity foodstuffs, like wheat, and in precious and non-precious metals. As markets adjust to higher commodity prices, currency uncertainties, and general lack of clarity, increased volatility and downward price pressure on all assets has ensued.
While these declines are uncomfortable, they are not abnormal and like the seasons they are likely cyclical. During a “winter storm”, like we are having now, it is instructive to look at the “weather” in previous periods and see if this period is truly extreme or more akin to a normal cycle.
Heading into the start of this year the stock market had doubled off its March 2020 low. It had been 20 months since a correction of at least 10%. In 29 of the last 50 years the market endured at least one 10% correction and so was due to shake out weak hands at some point this year. Below, is a chart of the frequency and depth of corrections in the SP500 back to 1928.
As you can see corrections of 10-20% are relatively common. Although, they often feel very uncomfortable when we are on the midst of one it is encouraging to see that we have been here before and eventually snapped strongly back.
We also think it is instructive to look at how markets have reacted to various geopolitical events over time. Below is a list of different events which lead to sizeable moves in the markets and the amount of time it took for the eventual recovery.
We think that the most relevant recent analogy might be the first Iraq war in the early 90’s. As you can see, the market dropped about 20%, after having had a major bull run. Much of the dip was driven by concern that a prolonged war in the Gulf would lead to higher oil prices and commodity inflation. Once the situation settled the market reclaimed its highs within a year. A similar situation could play itself out this time around, though we need an end to hostilities for the recovery to begin.
Fortunately, some asset classes, like long/short equities and managed futures, benefit from the current environment and volatility. These types of periods are why we maintain diversified portfolios and keep a long view. Just like we don’t throw out our Winter coats when Spring comes, knowing Winter will return, we hold assets that perform well in different seasons.
We continue to be believers in the investing truism that when you least expect it the cycle will turn and what once was dear will appear unwanted and what was unwanted will suddenly be dear.
Rest assured also, that while we keep one eye on the current cycle we keep our other eye on the horizon knowing that the weather will again change and other opportunities will present themselves.
On a final note, while we try to keep an unemotional eye on the markets and investing we would be remiss not to mention that beneath the headlines there is a true tragedy taking place in the Ukraine. Fathers, mothers, sons, and daughters having their lives interrupted and finding themselves in harms way. Our thoughts and prayers are with all people suffering during these turbulent times.