Markets Look Forward. So Should Investors

 

Sudden drops in the market and heightened volatility can be unnerving, as can rapidly changing economic policies. The market’s job is to process uncertainty in real time. When trade policies change swiftly, markets are incorporating a vast amount of information and expectations about how these shifts may shape the global economy. Markets do this on a forward-looking basis, continuously incorporating new information and setting prices so that expected returns are positive. 

 

Economic policies, such as those related to international trade, have financial impacts across the economy beyond market returns. The economic implications that markets almost instantaneously price into securities play out over a longer period in the real economy. This difference in velocity is important to underscore, because it points to a difference in how we experience potentially negative (or positive) economic developments as investors versus as participants in the real economy. Even if you are worried about ongoing economic challenges, you shouldn’t necessarily expect a negative investment experience going forward, because markets have already factored in known information. 

 

Pain you may feel now reflects markets setting prices such that expected returns are always positive. When we examine US equity returns following downturns of 10%, 20%, or even 30%, we see one-, three-, and five-year cumulative returns that are positive on average. Viewed in annualized terms across five years, returns after a 20% decline have been close to the US market’s historical average of approximately 10%. 

 

When your portfolio experiences a sudden drop, generally the most important thing an investor can do is to stay invested and look forward to better days ahead.