To paraphrase Ernest Hemingway, shifts in the stock market often occur “gradually, then suddenly.” Over the past month, the market has rotated from large cap technology stocks to small caps and other sectors. Following the latest jobs report, however, global stocks experienced a sharp pullback due to concerns over the timing of Fed rate cuts, a weakening labor market, and disappointing tech earnings. Financial markets are on edge as investors adjust to a changing economic landscape
Specifically, the Nasdaq is now in correction territory, defined as a 10% decline from recent highs. The S&P 500 has pulled back 5.7% from its high three weeks earlier, while the Dow has been steadier with a decline of 3.5%. The VIX, often described as the market’s “fear gauge,” has surged to its highest level since early 2023. The 10-year Treasury yield has now fallen below 3.8%, a sharp decline from 4.7% only three months ago.
How should investors view recent stock market swings as they position for the coming months
Investors need perspective in volatile markets
Investors focused on recent performance alone would no doubt wonder if the cycle is over. While recent market events are still playing out, it’s important to remember that not only are stock market swings normal, but they can also be healthy if they are the result of investors adjusting to new economic facts. This is especially true if valuations improve as prices adjust and corporate earnings continue to grow.
For many investors, the volatility since 2020 may already seem like a distant memory after the steady recovery of the past year and a half. As the accompanying chart shows, the S&P 500 has gained 113% over the past five years, including the pandemic collapse and the 2022 bear market. While market pullbacks are never pleasant, viewing the market on these timescales does help to put the current decline in perspective.
It's no secret that technology-related stocks, particularly those related to artificial intelligence, have contributed greatly to these market returns. The Magnificent Seven, a group of stocks including Nvidia that benefits from recent trends, is still up a whopping 162% since the beginning of 2023, and has gained 362% since early 2020.
The rotation and now pullback in these stocks is the result of investor concerns over the magnitude of the rally and large tech company earnings. Whether AI and large language models can live up to their lofty promises has yet to be seen, and it’s not surprising that investors are growing antsy at seeing a return on the billions invested by large companies in these technologies.
So far, market fundamentals still appear to be strong regardless of how stocks move in the short run. Profit forecasts are still positive, with S&P 500 earnings expected to grow 13% over the next 12 months. More than half of S&P 500 sectors are expected to grow earnings by double digits, and all 11 sectors are forecasted to experience positive growth. In the long run, earnings are what drive stock market returns, and thus the health of the economy matters more than short-term stock and sector-specific trading activity.
Investing is never a sure thing. In the classic book “A Random Walk Down Wall Street,” author Burton Malkiel writes that “the stock market is like a gambling casino where the odds are rigged in favor of the players.” Investing in the stock market comes with many risks that can be managed with proper portfolio construction and a longtime horizon. History shows that despite the ups and downs of the market, staying invested is still the best way to grow wealth and achieve financial goals over the course of decades.
