Even Good Years have Bad Days

May 24, 2021 | Richard So


What is your reason for this volatility?

The month of May has been a volatile period for equity investors. Some have tried to explain it as part of a “normal” seasonal pattern of weakness for the market. The old saying goes, “Sell in May, Go Away”. That being said, we would suggest you relook at your investment approach if your entire strategy hangs on a catchy rhyme! Some market analysts have offered other explanations, citing that the US Tax deadline was extended to May 17th, hence there may have been additional selling momentum in the first half of the month as investors generate cash to pay their tax bills. Although this may seem like a “cute” excuse for selling, there could be some credence to this as the early days of the COVID crisis saw massive liquidations from investors who had amassed tremendous capital gains spanning over a decade. The taxes from these 2020 realized gains would be due this year. Finally, others may blame the volatility on the increased expectations of higher inflation, which may incentivize a rotation out of technology and growth stocks. The sales and profits from these companies can take a long time to appear, hence why they are typically considered long-term investments. However, long-duration assets are punished the most by inflation as it discounts the value of these long-term profits. The research firm Fundstrat estimates that within the SP500, the Technology sector plus FANG (Facebook, Amazon, Netflix, Google) account for almost 40% of the entire market. Hence, heavier selling in these names and sectors could surely shake the stability of the overall market.

Regardless of the reason, history has repeatedly shown us that market pull backs are not necessarily indicative of how the full calendar year may perform. As seen in the chart below, large pullbacks within money-making years are common events. In fact, about 55% of years have price drawdowns of 10% or more.

Much of the financial media has reported inflation as the most popular cause for the recent volatility. Whether this is the true reason is unknown. However, as portfolio managers, we would be more than happy for a correction to be caused by this kind of news. Within a new business cycle, this inflation is a result of effective vaccine distributions, falling unemployment, pent-up consumer demand, greater business confidence, and raging economic growth. I can’t think of a better backdrop to ride out any short-term volatility.

At the time of this writing, the SP500 and Nasdaq100 indexes are respectively -2% and -6% below their all-time highs. This is far from the levels of a correction (-10%) or a bear market (-20%). As the chart above reminds us, we may see further volatility to come, however, it seemingly appears that good things come to those who wait.