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Investment Strategy

5 considerations to make the most of market volatility

There is no question that the market environment has changed.

Obviously, stock prices are lower. The S&P 500 is currently -6% below its all-time high reached in the middle of July, Europe is down more than 8% from its highs, and Japanese stocks endured a full bear market over the course of two weeks.

Bond yields are also lower. Ten-year U.S. Treasury yields are down by -30 basis points (bps) over the last two weeks. Two-year yields, which are more sensitive to changes in the outlook for Federal Reserve policy, have collapsed by nearly -50 bps over the same time frame.

Implied volatility is also higher. The S&P 500 needs to move 1.5% in either direction daily for the next month to justify the currently level of implied volatility (VIX Index) versus just an 0.8% daily move two weeks ago.

We believe these changes are driven by three main factors that drove investors to flee crowded positions:

Growth scare: There is a higher risk of U.S. recession now than there was just two weeks ago. The jobs data released at the beginning of August were weak and triggered the “Sahm Rule”, which has coincided with every recession since 1970. We don’t believe the economy is currently in recession, and still believe the most likely outcome is continued expansion. Layoffs are low, corporate profits are rising, margins are healthy, and output is solid. That said, the Fed likely doesn’t have the flexibility to wait and see. We think it’s on the precipice of a material easing cycle. The message for investors is clear: Cash is likely set to underperform bonds, as it has in 11 of the 12 easing cycles over the last 50 years.
AI skepticism: There is more skepticism around the earnings benefits from artificial intelligence (AI). Earnings season from the perceived “AI winners” was solid yet unspectacular. This is part of the problem. Investors had grown more optimistic that AI would start to show a more pronounced return on investment. If there was an “AI premium” embedded in the market, it is largely gone. The tech-heavy Nasdaq 100 is now underperforming the broad market year-to-date. The forward price-to-earnings ratios for three of the four “hyperscalers” are lower now than when they were at the start of the year. We believe AI has the potential to drive meaningful economic, productivity and earnings benefits over the next decade. The stocks that could be best positioned to benefit are trading at a premium to the market, but don’t look too stretched relative to their own history.
The U.S. election: Long-term investors are probably best served to focus more on strategic asset allocation and implementation decisions than shifting perceptions of election outcomes, but they do seem to drive markets in the short term. Since the middle of July, implied election odds have moved back to an effective toss-up from the previous greater-than-70% chance President Trump would be re-elected. The stock market is not reacting to one candidate or another as much as it is reacting to a more uncertain outlook for the outcome in November. That necessitates lower valuations.

We still have a constructive view on markets despite a more pronounced risk of a more material growth slowdown. As we move through the end of the summer and into the autumn, we will likely view increased volatility as an opportunity to put money to work across asset classes.

Spotlight: Five considerations to make the most of market volatility

Market volatility may be normal, but it should still spark action. In the rest of today’s note, we list five approaches we think investors can consider to make the most of the sell-off.

This chart shows the MSCI World calendar year price returns and maximum intra-year drawdowns from 1980 to August 2024. In 1980, the calendar year price return was 21% and the maximum intra-year drawdown was -16%. In 1981, the calendar year price return was -8% and the maximum intra-year drawdown was -18%. In 1982, the calendar year price return was 6% and the maximum intra-year drawdown was -20%. In 1983, the calendar year price return was 19% and the maximum intra-year drawdown was -6%. In 1984, the calendar year price return was 2% and the maximum intra-year drawdown was -14%. In 1985, the calendar year price return was 37% and the maximum intra-year drawdown was -5%. In 1986, the calendar year price return was 39% and the maximum intra-year drawdown was -9%. In 1987, the calendar year price return was 14% and the maximum intra-year drawdown was -24%. In 1988, the calendar year price return was 21% and the maximum intra-year drawdown was -9%. In 1989, the calendar year price return was 15% and the maximum intra-year drawdown was -7%. In 1990, the calendar year price return was -19% and the maximum intra-year drawdown was -26%. In 1991, the calendar year price return was 16% and the maximum intra-year drawdown was -11%. In 1992, the calendar year price return was -7% and the maximum intra-year drawdown was -14%. In 1993, the calendar year price return was 20% and the maximum intra-year drawdown was -6%. In 1994, the calendar year price return was 3% and the maximum intra-year drawdown was -8%. In 1995, the calendar year price return was 19% and the maximum intra-year drawdown was -4%. In 1996, the calendar year price return was 12% and the maximum intra-year drawdown was -6%. In 1997, the calendar year price return was 14% and the maximum intra-year drawdown was -10%. In 1998, the calendar year price return was 23% and the maximum intra-year drawdown was -21%. In 1999, the calendar year price return was 24% and the maximum intra-year drawdown was -7%. In 2000, the calendar year price return was -14% and the maximum intra-year drawdown was -19%. In 2001, the calendar year price return was -18% and the maximum intra-year drawdown was -31%. In 2002, the calendar year price return was -21% and the maximum intra-year drawdown was -31%. In 2003, the calendar year price return was 31% and the maximum intra-year drawdown was -14%. In 2004, the calendar year price return was 13% and the maximum intra-year drawdown was -8%. In 2005, the calendar year price return was 8% and the maximum intra-year drawdown was -7%. In 2006, the calendar year price return was 18% and the maximum intra-year drawdown was -12%. In 2007, the calendar year price return was 7% and the maximum intra-year drawdown was -11%. In 2008, the calendar year price return was -42% and the maximum intra-year drawdown was -51%. In 2009, the calendar year price return was 27% and the maximum intra-year drawdown was -27%. In 2010, the calendar year price return was 10% and the maximum intra-year drawdown was -17%. In 2011, the calendar year price return was -8% and the maximum intra-year drawdown was -23%. In 2012, the calendar year price return was 13% and the maximum intra-year drawdown was -13%. In 2013, the calendar year price return was 24% and the maximum intra-year drawdown was -8%. In 2014, the calendar year price return was 3% and the maximum intra-year drawdown was -10%. In 2015, the calendar year price return was -3% and the maximum intra-year drawdown was -14%. In 2016, the calendar year price return was 5% and the maximum intra-year drawdown was -12%. In 2017, the calendar year price return was 20% and the maximum intra-year drawdown was -2%. In 2018, the calendar year price return was -10% and the maximum intra-year drawdown was -20%. In 2019, the calendar year price return was 25% and the maximum intra-year drawdown was -6%. In 2020, the calendar year price return was 14% and the maximum intra-year drawdown was -34%. In 2021, the calendar year price return was 20% and the maximum intra-year drawdown was -6%. In 2022, the calendar year price return was -19% and the maximum intra-year drawdown was -27%. In 2023, the calendar year price return was 22% and the maximum intra-year drawdown was -11%. The last data point is as of August 2024, where the year-to-date price return was 9% and the maximum year to date drawdown was -8%.

Revisit your plan. Use this period of market volatility as an opportunity to revisit a comprehensive wealth plan. This ensures that financial goals are clearly defined and aligned with your long-term objectives. When portfolios are properly aligned with intent, it is likely they are also designed to withstand this type of volatility. Don’t have a plan? Use the sell-off to put a holistic plan in place. It could help relieve the trepidation associated with the next one.

Rebalance your portfolio. Review and rebalance portfolios to maintain your strategic asset allocation. Equities have pulled back and fixed income has rallied, which may result in unwanted drift. Last week, to maintain proper levels of exposure, we added to equities in portfolios that we manage on behalf of clients.

Put idle cash to work. Using stock market pullbacks to increase equity exposure can be a prudent strategy. Average returns for the S&P 500 12 months after a 5% pullback are nearly 12%, and markets are higher nearly 75% of the time. Nervous about more volatility? Consider structured investments. Structured products are typically misunderstood as overly complex and risky financial instruments. But when used correctly, derivatives can enhance a portfolio by offering the potential to participate in some market appreciation with an inbuilt downside buffer.

Lock in yields. Yields are falling fast now that it seems the global cutting cycle might come faster than previously expected. Investment grade yields in excess of 5% in the U.S. and 3.5% in Europe are elevated compared to what we saw over the last decade, but may not be there for long. History suggests that core bonds have outperformed cash by an average of 14% over the last 12 Fed cutting cycles.

Keep things in perspective. The global stock market has returned nearly 10% this year and has sold off by over 5% from prior all-time highs. The average year that ends with a gain comes with a 15% peak-to-trough drawdown. The cost of outsized returns from equity markets is this type of volatility. Also, if the bull market that started in October 2022 is really over, it would be the shortest on record. Instead, it seems more likely to us that this bull market will extend toward the median gain of 110% over four years from its current length of 40% in less than two years.

Volatility can be uncomfortable. Your J.P. Morgan team is here to help you make the most of it.

All market and economic data as of August 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

Structured products involve derivatives and risks that may not be suitable for all investors. The most common risks include, but are not limited to, risk of adverse or unanticipated market developments, issuer credit quality risk, risk of lack of uniform standard pricing, risk of adverse events involving any underlying reference obligations, risk of high volatility, risk of illiquidity/little to no secondary market, and conflicts of interest. Before investing in a structured product, investors should review the accompanying offering document, prospectus or prospectus supplement to understand the actual terms and key risks associated with each individual structured product. Any payments on a structured product are subject to the credit risk of the issuer and/or guarantor. Investors may lose their entire investment, i.e., incur an unlimited loss.

The risks listed above are not complete. For a more comprehensive list of the risks involved with this particular product, please speak to your J.P. Morgan team.

Fluctuations are no reason to sit still. Here are some actions investors can take.

Jacob Manoukian Head of U.S. Investment Strategy

Published Aug 12, 2024

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