Seeking Stability in a Volatile Market
Despite a relatively steady year in 2021, stock market volatility has roared back in 2022. In January, the average daily high-low spread of the S&P 500 was 2.06% – more than twice as high as in January 2021. In February, the S&P 500 experienced no highs for the first time since October 2020.
With 78% of U.S. investment professionals expecting a rise in stock market volatility as we progress into 2022, many are looking to prepare their portfolios for turbulence.
Let's look back at the history of stock market volatility, discuss why equity markets tend to react and learn what options are available to help safeguard against risk.
The Stock Market's Recent Volatility
On average, the S&P 500's daily movement up or down is approximately 0.76%. However, volatility often becomes more severe as a result of macroeconomic conditions. For instance, the Dow Jones swung more than 3% over 30 times between February and June 2020, as uncertainty surrounding COVID-19 continued. Meanwhile, the S&P 500 gained or lost more than 2% just seven times in 2021, as the economy slowly recovered with the aid of government stimulus.
One primary measurement of stock market volatility is the CBOE Volatility Index (VIX), which represents the market's expectation for volatility over the next 30 days. In January 2018, the VIX closed below 10 seven times. Since then, the VIX has not witnessed a day in single digits; in fact, during the uncertainty surrounding COVID-19 in March 2020, the VIX spiked as high as 82.69.
The VIX long-term average is roughly 19.5. Today, the closing price is almost 25.0, meaning the stock market is officially more volatile than average.
What Causes Heightened Volatility
There are several reasons why the stock market might drop (or skyrocket):
- Government Action: Though many factors contributed to Black Monday in 1987, many believe the ultimate catalyst was a bill passed by the House Ways and Means Committee that repealed certain tax breaks. While governing bodies do have the power to prevent or delay economic volatility, they also risk triggering heightened volatility through their policy-making decisions.
- Equity Valuations: It is estimated that up to 10,000 new tech enterprises launched during the late 1990s. Given the influx of capital into the space, these companies were typically overvalued by 40%, creating what we know as the 2000 Dot-Com bubble. As these businesses failed to generate profits or positive cash flow to support operations, demand waned for these speculative stocks. By mid-2003, around 4,800 had been sold or filed for bankruptcy.
- Leverage Effect: Margin debt is money that a broker lends to an investor. Leading up to the 2008 Global Financial Crisis, margin debt spiked, meaning a record number of dollars invested used borrowed money. As the stock market began to falter, investors faced margin calls and potential losses greater than the amount of capital they had personally invested. Many investors were forced to liquidate their holdings, causing the S&P 500's volatility to increase by 325% in 2008.
- Uncertainty: Investors like to know what will happen next; when they are uncertain, it is statistically proven that markets become more volatile. As we saw with the COVID-19 pandemic, stock market volatility across the board increased as the pandemic emerged. As more information became available, volatility began to subside. As Peter Lynch once said, "Everyone has the brainpower to make money in stocks. Not everyone has the stomach."
A Glance At Current Macroeconomic Conditions
While past performance does not guarantee future results, history can help investors predict how certain events might impact their portfolios. Today, all four conditions discussed above can be seen in the present market, posing a significant risk for investors:
- To curb inflation, the Federal Reserve is planning to raise interstate rates throughout 2022. Many expect the Fed to raise interest rates by 0.25% at its next meeting in March, the first increase in three years.
- Many small-cap stocks have recently experienced dramatic valuation crashes similar to the dot-com bubble. Even with a sluggish start to 2022, equity markets – primarily propped up by large-cap stocks – continue to appear severely overvalued.
- Leading up to the 2008 crash, total margin debt topped $500 billion for the first time in history. In January 2022, margin debt almost hit $830 billion. Despite peaks in November 2021, both margin debt and the NASDAQ have since fallen by double-digits.
- Despite COVID-19 vaccine rollouts and the easement of many government health mandates, the world continues to face heightened uncertainty as both pandemic-induced supply chain disruptions and geopolitical conflict contribute to rises in global energy and food prices.
Volatility's Impact on Portfolios
With record stock volatility and federal interest rates on the horizon, many are starting to challenge the value of the long-standing 60/40 portfolio.
During the 2008 Financial Crisis, a traditional 60/40 portfolio lost, on average, almost 16% of the total value. In January 2022, the Bloomberg 60/40 index experienced its worst month since the beginning of the COVID-19 pandemic. Moreover, from January 1991 through August 2021, a 60/40 portfolio experienced an average Sharpe ratio of 0.7. Typically, a Sharpe Ratio value less than 1.0 means that an investment's returns will be lower than expected given the level of risk.
One emerging issue leading to this less-than-ideal performance is that stocks are becoming heavily centralized. Over 20% of the S&P 500's weight comprises four companies: Apple, Microsoft, Amazon, and Google. As seen by Facebook's record market cap loss in February 2022, a single company can drive even the largest indexes down.
Volatility can also impact the fixed-income portion of traditional portfolios. In today's low-yield environment, fixed-income assets do not provide strong downside protection to investors as they have in the past. During the 2008 Financial Crisis, U.S. Corporate High Yield bonds produced net losses, while Total U.S. Corporate bond markets generated near-negative actual returns after adjusting for inflation. As the world began to recover from the COVID-19 pandemic in 2021, U.S. Treasury Bonds generated a -4.42% return.
Farmland's Stable Performance
Investors looking to hedge against volatility might want to begin diversifying beyond stocks and bonds. One asset class, recently made accessible through FarmTogether, is worth exploring: farmland.
Over the past several volatile economic cycles, farmland has performed remarkably well. Let's take a closer look:
- During the crash of 1987, farmland prices remained relatively stable. Values did drop in the earlier half of the 80s, soon only to rebound; after navigating tight monetary policies from the Federal Reserve, combined with heavy debt financing earlier in the decade, farmland values increased an average of 5% between 1988 and 1989.
- During the Dot-Com crash, the NCREIF Farmland Index posted a positive return each year from 2000 to 2002. While speculative tech companies experienced severe losses, farmland retained its value as the demand for food and other commodities remained stable.
- During the 2008 Global Financial Crisis, the average cost per acre of farmland increased by 8%. Farmland performed exceptionally well compared to other real assets, particularly real estate, due to agriculture's traditionally low debt-to-equity ratios. While changes to capital markets did impact farmland values in certain parts of the country, the value of crop production still set a new record in 2008 with a 20% year-over-year increase, and the decline in real estate prices did not lead to a widespread corresponding decrease in farmland values.
- During the COVID-19 pandemic, the global demand for food remained steady. In fact, as a result of global supply chain disruptions, this demand for food caused commodity prices to surge; crop production values for the 2020-21 season increased by 18%. Rising crop prices led to increasing land valuations. Last year, land values rose approximately 7% across the United States.
A Simple Solution During Complex Times
As uncertainty continues in 2022, global markets aren't entirely sure what to expect. Although financial markets are far from predictable, some investment opportunities, such as farmland, have historically prevailed despite larger economic trends.
Today, farmland is more accessible than ever before. FarmTogether offers a wide range of investment offerings through a variety of channels, each suited to fit investors' unique needs. If you're looking to shed portfolio risk without sacrificing returns, you might want to consider farmland.
Interested in learning more about farmland as an asset class? Click here to see farmland's historical performance, visit our FAQ to learn more about investing with FarmTogether, or get started today by visiting ways to invest.
Disclaimer: FarmTogether is not a registered broker-dealer, investment adviser or investment manager. FarmTogether does not provide tax, legal or investment advice. This material has been prepared for informational and educational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.