U.S. stocks fell Friday, extending a run of weekly losses into its third straight week, as investors reacted to a handful of disappointing earnings reports and the Federal Reserve’s increasingly aggressive language about future interest rate increases. The losses were broad-based, with all 11 industrial sectors tracked by S&P ending lower. With its nearly 2.8% drop on Friday, the S&P 500® Index is now down 10.4% for the year so far.
Markets have grown more volatile as the Fed’s plans for tamping down historically high levels of inflation have evolved in the face of persistent price increases. Fed Chairman Jerome Powell suggested Thursday that the central bank may be envisioning a quicker series of rate hikes than was previously expected. Markets are now bracing for a half-point increase in May—a much sharper move than the quarter-point hike in March—with more tightening to come later in the year.
“We’re likely to see more spikes in volatility as the Fed embarks on a more aggressive pace of rate hikes, even as it starts to shrink its behemoth $9 trillion balance sheet,” says Liz Ann Sonders, Schwab’s chief investment strategist. “As monetary conditions tighten against a backdrop of high oil prices, war in Ukraine, and a lingering pandemic, the risk of recession increases. Equity investors should limit their risk-taking and use rebalancing to maintain strategic allocations.”
U.S. stocks: Not all is as it seems
- The mid-March rally in U.S. stocks wasn’t as strong as it appeared, as more-defensive sectors and more-speculative areas of the market outperformed the more-cyclical sectors we’d expect to see leading a sustained rise in the benchmark indexes.
- Sector volatility and a rapid turnover in sector leadership are likely to continue, given all the sources of uncertainty hitting the market. Schwab recommends stock investors stick with a sector-neutral approach for the time being.
Global stocks: Look to the short term
- Central banks around the world are likely to join the Fed in trying to ratchet back inflation, as a strong global economy continues to put upward pressure on prices.
- Rising interest rates could favor shorter-duration stocks, which generate more of their cash flows in the near-term rather than the distant future and are more prevalent in international markets. Such stocks have historically outperformed when interest rates are climbing.
Bonds: Higher yields create potential opportunities
- Rate-hike expectations have pushed bond yields higher, with two-year Treasury yields up nearly 200 basis points so far this year and 10-year yields up by 140 basis points, making for a flatter yield curve. However, we believe the worst of the rise in yields is behind us since the market is already pricing in a lot of the expected tightening.
- Higher yields have created potential opportunities for fixed income investors, who can now earn better yields than we’ve seen in three years. We still suggest investors focus on higher credit quality bonds, such as Treasuries and investment grade municipal and corporate bonds, as riskier segments of the market typically don’t do as well during tightening cycles.
Trading takeaways: Volatility is likely to continue
- Key technical support levels have been broken again. After closing below the 50–day SMA on Thursday, the S&P 500 is now solidly below its 50–, 100–, and 200–day SMA and is once again in correction territory for the first time since March 15. The Nasdaq Composite index, which had been in correction territory for the past two weeks, fell back into a bear market. Corrections are generally defined as a major index falling by more than 10% (but less than 20%) from its most recent peak. Bear markets are periods when an index is down by 20% or more.
- Volatility remains elevated. The Cboe Volatility Index (VIX) was implying daily moves in the S&P 500 Index of 63 points in either direction, though Friday’s top-to-bottom range actually exceeded 115 points.
- Equity traders should consider shrinking the size of their trades. Sharp bounces higher are just as plausible as large moves lower in the near term.
What should long-term investors do now?
Market volatility is unsettling, but historically not unusual. If you’ve built an appropriately diversified portfolio that matches your time horizon and risk tolerance, it’s likely the recent market drop will be a mere blip in your long-term investing plan.
However, it can be hard to do nothing when markets are rough. Given what has been happening recently, consider a few of our investing principles:
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Don’t try to time the markets. It’s nearly impossible. Time in the market is what matters. While staying the course and continuing to invest even when markets dip may be hard on your nerves, it can be healthier for your portfolio and can result in greater accumulated wealth over time.
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Build a diversified portfolio based on your tolerance for risk. It’s important to know your comfort level with temporary losses. Sometimes a market drop serves as a wake-up call that you’re not as comfortable with losses as you thought you were, or that a portfolio you assumed was appropriately diversified in fact isn’t. Schwab clients can log in and use the Schwab Portfolio Checkup tool to quickly assess whether their portfolio is still in balance with their target asset allocation. If you’re not a client, or haven’t yet established an investment plan, our investor profile questionnaire can help you determine your profile and match it to an appropriate target asset allocation.
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Rebalance your portfolio regularly. Market changes can skew your allocation from its original target. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio, and moving the proceeds to positions that have become underweight. It’s a good idea to do this at regular intervals. Schwab clients can log in and use the Schwab Portfolio Checkup tool to identify areas of their portfolio that may have drifted away from their target asset allocation.
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Build in protection against significant losses. Modest temporary losses are one thing, but recovery from significant losses can take years. Traditionally defensive asset classes, such as cash investments and short-term bonds, tend to perform better when stocks are down. When used for diversification, they can help buffer a portfolio against the effects of up-and-down markets. You’ll also want to consider defensive assets for shorter-term goals or accounts from which you expect to draw money within the next few years.
© Charles Schwab
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