If the market has felt unusually jumpy lately, you’re not just imagining things. Investors, though, should remember that elevated volatility doesn’t have to be a signal of darker days ahead for stocks.
Based on the standard deviation of monthly returns—a measure of how much a portfolio’s value swings month to month—investors over the past 3 months have experienced some of the highest levels of volatility recorded since the 1940s.
After dropping 9% in March after the Iran conflict began, the S&P 500® Index quickly recovered, surging almost 20% through May and reaching new highs on June 2. Stocks lost ground in late July amid concerns about higher oil prices, sustained by ongoing Middle East tensions, as well as worries about inflation and the Fed’s capacity to tame it. Then, just as suddenly, the market on August 4 set a new record high on renewed optimism for the Middle East, AI spending, and the US economy.
The market’s turnabout has many investors understandably nervous about their portfolios, but volatility isn’t generally a warning sign for the direction of future returns. In fact, the higher the starting point for volatility, the stronger subsequent stock returns have tended to be.
As uncomfortable as market turbulence can make us feel, volatility has often been a feature of healthy bull markets, rather than a signal of their demise.
Should investors worry about stock market volatility?
In recent weeks, a period of widespread bullishness quietly came to a halt, sparking questions about how much longer the good times would last.
Analysts began warning that AI-related company shares were priced to perfection, while investors began questioning the historic levels of capital spending by Mag 7 technology leaders and the AI hyperscalers. That reassessment has sparked a rotation out of high-flying tech shares, especially chipmakers, into financials, health care, small caps, and value-oriented sectors.
Yet what's interesting about the recent volatility isn't the magnitude but its persistence.
The current bull market has spent more time in the highest quartile of volatility than any other period in the historical record. That may sound alarming, but one of the defining features of this cycle has been the longer duration of key trends, whether it is valuations, earnings strength, or price volatility.
The encouraging news for investors is that today’s churn could give way to periods of continued price gains. When volatility begins in the highest decile, as it does today, the market has historically advanced 96% of the time and gained roughly 20% over the following year.1
Can stocks continue to rise if earnings growth slows?
One concern many investors might have is whether earnings can continue to grow at the unusually high rate we’ve seen this year. I believe that some degree of earnings growth deceleration over the next year is more likely than not, because growth is already near top-quartile levels.
Yet even decelerating earnings growth—profits that are rising, but at a slower pace—has historically not been a problem for market returns. In the past, markets have produced similar return profiles whether earnings growth was accelerating or slowing.
The difference shows up in price volatility. Periods of decelerating earnings growth tend to come with more back-and-forth market swings than periods of acceleration. In that sense, today's choppier environment may simply reflect what investors should expect as growth normalizes from unusually strong levels.
What should an investor do during periods of market volatility?
For long-term investors, the lesson from history is not to confuse volatility with deterioration. Markets rarely travel in a straight line, and some of the strongest advances have been accompanied by a surprising amount of discomfort.
In other words, higher returns often require investors to tolerate a bumpier ride.
The challenge isn't predicting the next stock market swing but rather resisting the temptation to react. Just remember: Market volatility rarely feels good in real time, but neither have some of the market's moments of greatest opportunity.
Denise Chisholm is director of quantitative market strategy in the Quantitative Research and Investments (QRI) division at Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing, and other financial products and services to institutions, financial intermediaries, and individuals.
In this role, Ms. Chisholm is focused on historical analysis, its application in diversified portfolio strategies, and ways to combine investment building blocks, such as factors, sectors, and themes. In addition to her research responsibilities, Ms. Chisholm is a popular contributor at various Fidelity client forums, is a LinkedIn 2020 Top Voice, and frequently appears in the media.
Prior to assuming her current position, Ms. Chisholm was a sector strategist focused on sector strategy research, its application in diversified portfolio strategies, and ways to combine sector-based investment vehicles. Ms. Chisholm also held multiple roles within Fidelity, including research analyst on the mega cap research team, research analyst on the international team, and sector specialist.
Previously, Ms. Chisholm performed dual roles as an equity research analyst and director of Independent Research at Ameriprise Financial. In this capacity, she focused on the integration of differentiated research platforms and methodologies. Before joining Fidelity in 1999, Ms. Chisholm served as a cost-of-living consultant for ARINC and as a Department of Defense statistical consultant at MCR Federal. She has been in the financial industry since 1999.
Ms. Chisholm earned her bachelor of arts degree in economics from Boston University.