A note about recent market volatility

A perspective from E*TRADE Securities 01/25/22

After starting 2022 with three straight down weeks, the US stock market kicked off this week with its biggest intraday decline (nearly 4%) since September 2020, fell briefly into correction territory (defined as a drop of 10% or more)—and then rebounded strongly to close higher on the day.

Rebounds off of 10% drops are not exactly uncommon.  Professional traders and institutional investors can set their strategies around big round numbers like these, with orders to buy certain securities when they’ve dropped to a threshold like 10%.  This systematic buying can create an upward trend.

Corrections are a natural part of the market, and they shouldn’t distract investors from their long-term goals.

After a long and relatively drama-free rally off the Pandemic-fueled March 2020 lows, volatility is back. But as noted in past Monthly Market Commentaries, including “Following up on another record year,” the type of one-way stock market conditions that prevailed for nearly two years are typically the exception, and not the rule, demonstrating that markets don’t always move in a straight line. And earlier this month in “Pricing a More Hawkish Fed,” Morgan Stanley strategists noted the potential for rate hikes and more aggressive tapering to account for a 10-20% correction in the S&P 500.

This is important for investors to keep in mind: Corrections are a natural—and unavoidable—part of the market. They’ve always occurred, they always will, and they shouldn’t distract investors from their long-term goals. That said, every market situation has some unique characteristics. Here are a few factors that may be contributing to the recent volatility:

● Anticipation of the Fed’s first interest rate hikes since 2018, and the dialing back of economic stimulus.

● Concerns that inflation may be hotter and longer-lasting than many had hoped.

● What has, so far, been an underwhelming earnings season, with some businesses citing interest rate and inflationary pressures.

● Geopolitical tensions, most notably the Russian troop buildup at the Ukrainian border.

Most importantly, though, may be the fact that the S&P 500 had rallied 84% between March 2020 and December 2021—the biggest such rally of the past six decades. Exceptionally large up moves are often followed by sharp give-backs, which are especially hard for investors to digest when we’ve grown accustomed to low-volatility, one-way market conditions.

Keep calm and carry on

Although no one can predict when the market will top or bottom, remembering a few key principles can make the market’s inevitable bouts of selling and volatility easier to navigate:

● Asset allocation and diversification are powerful tools. Diversifying across asset classes and investments is the foundation of a long-term investment portfolio, and it can help provide guardrails for weathering all market conditions.

● Assess your risk tolerance. It can be easy to lose sight of how much risk you are truly comfortable with. Investors with overly aggressive asset allocation may decide they want to adjust their mix to something more conservative. Alternatively, investors who are comfortable with their risk level may want to reassess the performance of riskier assets and rebalance accordingly. (Those with managed accounts can view their allocations on the Portfolios page.) For those with standard brokerage accounts, E*TRADE has a portfolio analysis tool that can help: When you’re in a particular portfolio, click on the Allocation & Risk tab and scroll down.

● Keep emotions in check. This is the biggest challenge. Just as investors should be cautious about chasing returns in a rising market, letting panic-inducing headlines influence trading in a “risk-off” environment can end up doing more harm than good. History has proven that trying to time when to enter and exit the market is typically a fool’s errand.

Bottom line: Investors need not be too fazed by volatility—it’s a natural part of the market process. Despite its inevitable and unpredictable setbacks, the stock market has a well-established long-term track record. The key is to not let the near-term “noise” knock you off that path.

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