The Market Narratives Are Volatile, Too

The narrative shift the last two days highlights the importance of taking a long-term view and shunning daily headline swings.

US stocks tumbled on Thursday, reversing Wednesday’s big surge, as the correction continued amid extremely dour sentiment. There is no question such swings, particularly coming back-to-back, can be confusing and challenging for investors. But, hard as it may be—particularly during a correction’s throes—it is critical not to overthink day-to-day moves. The fast track to allowing markets’ swings to cause you to lose your mind is, in my view, to read and believe the theories about what “explains” daily market movement. This week is a case-in-point, as illustrated near perfectly by coverage of the Fed’s “supersized” 50 basis point (bp, or 0.50 percentage point) hike.

As our commentary yesterday noted, in the immediate wake of the Fed’s widely watched move, markets didn’t materially respond, alternating between small dips and modest gains. But as Fed head Jerome Powell took to the podium and poured cold water on the notion a 75 bp hike may loom at the next meeting, they soared. Instead, he noted that a series of 50 bp hikes may be what follows. Nothing here said anything clear about the path forward for hikes. Nothing provided vast insight into the economic outlook. So commentators drew their own conclusions.

As stocks soared, pundits assured readers the 50 bp hike and Powell’s subsequent chatter was bullish—it curtailed fears of an even more hawkish Fed ahead. “‘It was a relief rally on the back of the 75s being taken off the table.’”^[i] Another observer argued that despite the big hike, “The Fed’s messaging, however, helped put investor anxiety at ease … ‘There’s a feeling they’re heading into the right direction,’ he said. The central bank, he said, has shown it is taking inflation seriously, but not giving the impression that it will surprise investors with the size of subsequent rate increases.”^[ii] 

Elsewhere, coverage near-identically argued that in Powell’s speech, “… investors found a reason for relief. While the Fed raised interest rates half a percentage point and its chair, Jerome H. Powell, said similarly large increases would be ‘on the table’ at the Fed’s upcoming meetings, he shot down the idea that policymakers were considering an even larger move, as some investors had feared.”^[iii] Other coverage was even more sanguine, “All it took was a few phrases in a day otherwise rife with hawkish pronouncements from a central bank bent on subduing the hottest inflation in 40 years. While stocks initially wobbled on confirmation the Fed had pushed up interest rates by 50 basis points, the S&P 500 took off when Powell said an even bigger increase is ‘not something that the committee is actively considering’ for coming meetings.”^[iv]

So the market narrative seemed set after Wednesday: The 3% S&P 500 surge was due to the Fed’s dialing back expectations of an even more hawkish approach going forward.

Until Thursday. When stocks plunged at the open and retraced the entirety of the rally, the narrative did a 180°. Apparently, after sleeping on it, markets awoke and decided that, “By pushing back on a jumbo-hike of 75 basis points in June, Fed Chair Jerome Powell beat back the market’s most-aggressive predictions for the path of interest rates on Wednesday. However, he may also have inadvertently set the stage for more turbulence going forward. It’s still a very rocky road ahead, with pivotal economic data and global developments due within days that could seed doubts about the central bank’s approach.”^[v] Or that, “Many investors are now questioning how high the Fed might raise rates over the next two years amid soaring inflation and how that might ripple across the economy and corporate profits.”^[vi]

Really, of course, nothing material changed overnight. A single event cannot possibly be inherently bullish one day and negative the next. The 50 bp hike we got yesterday was still the same. No Fed speaker had offered further wisdom. The path of interest rate hikes in the future had long been questioned by investors and it is just as unknown today as yesterday—and just as unknowable as it will be tomorrow (or next month, next year, etc.). Just as they didn’t yesterday, few noted today that Fed rate hikes, whether 25 or 50 bps or coming in a fast or slow sequence, aren’t the bearish force people presume.

The only thing I see that did change: Market volatility shifted from heading upward yesterday to downward today, re-shaping the narrative in the process. Narratives are fine, but it is important to recall they are opinions, not facts. With that in mind, consider something The Wall Street Journal’s Chao Deng once noted in a 2011 piece for the Columbia Journalism Review:

When reading a typical stock-market story, one that says something like, “Futures Gain Ahead of Obama Jobs Plan,” did you ever think to yourself: “How do we really know the market move had anything to do with the president’s jobs plan? Says who?

Says me. I’m a markets reporter. It’s what I do.^[vii]

Deng went on:

I wanted a beat with broader appeal. And sure enough, less than three months after the switch [to covering markets], page-views on my stories were soaring. My new-found popularity wasn’t because I had suddenly became a brilliant writer. It was because a volatile turn in the markets simply begged for an explanation, sending thousands of extra readers my way. [Boldface ours.]

These words are as fresh today as they were 11 years ago. My take on Deng’s words is this: Sometimes, much of the time, what markets do on a daily basis isn’t explicable. So to keep your head, take a longer-term perspective. That is the basic underpinning of legendary investor Benjamin Graham’s famous quote: “In the short term, markets are voting machines. But in the long run, they are weighing machines.” It is the wisdom behind John Pierpont Morgan’s glib reply when asked his opinion of what the market would do that day, “It will fluctuate.”

In a sense, this all harkens back to events from 12 years ago tomorrow—2010’s “Flash Crash,” which struck amid the 2009 – 2020 bull market’s first correction. On May 6, 2010, a sudden midday drop and recovery, all coming within about 45 minutes, stirred widespread fear. Explanations for what happened ranged from brittle markets worrying over bigger problems (chiefly, Greece), to hackers, high-frequency trading issues, technical glitches and fat-finger trades. But to long-term investors, those were never more than noise. The great irony of the Flash Crash is it came less than 14 months into an almost 11-year long bull market. Overthinking the daily swing was much more dangerous than the event itself, in my view.

The correction we have endured this year, including the past two days, has been trying for many. That is entirely understandable. But it can be a great help either to opt out of monitoring every tick on TV or, at least, to question the narratives so many tell you explain what you are seeing. The challenge we all face as investors during sharply negative periods like those of late is pretty basic: The moves make you feel that matters are of the utmost urgency, when in reality the urgent need is to take a long-term view.

When in doubt, ask yourself this basic question: Will today’s swings matter much to my portfolio’s returns over my entire time horizon, whether that is 10, 20 or more years? Markets’ long-term trajectory has always been jagged but up. In bull markets, the good days swamp the bad. How you react to those swings will have much more influence over your returns than the mere fact that these swings happen.