Capital market insights Conversation guide February 2018 Volatility returns, fundamentals remain strong If record-low volatility and more than a year of positive monthly returns on the S&P 500 Index had lulled investors into complacency, that came to an abrupt end this month. With the sell-off, investor sentiment reversed completely, and CNN s Fear & Greed Index fell from a reading of 76 ( extreme greed ) to 8 ( extreme fear ). 1 Several factors account for the February correction, including higher interest rates, rising inflation and concerns about valuations. But given the sharpness of the January rally, a correction was not unexpected. The S&P 500 advanced 5.7% (including dividends) that month, the best such performance in nearly two years, and this followed strong returns in 2017. Dire headlines may have contributed to this month s reversal in sentiment, possibly leading some investors to react emotionally. But if history is any guide, investors would be wise to ignore these shortterm ups and downs and take a long-term view. Market pullbacks are not unusual, and this one ends a long period of abnormal calm. Volatility should not be too worrisome; in a bull market, pullbacks and even corrections can be sharp but short-lived. This bull may have room to run, given that fundamentals remain strong. 1 as of February 9, 2018
Market pullbacks are not unusual, and this one ends a long period of abnormal calm. The sell-off in early February was overdue. It marked the first time in 404 trading days that the S&P 500 had lost at least 5% the longest such period ever recorded To understand how unusual this period was, consider that on average the market has experienced a pullback a downward move of 5% or more every 50 trading days, or every two-and-a-half months; this period of calm persisted for 19 months and included 15 straight months with a positive return (see chart below) Historically, spikes in volatility have not necessarily marked the beginning of a bear market; in the current bull, the VIX index surged when China devalued its currency (August 2015), when the U.S. credit rating was downgraded (August 2011) and in the midst of the flash crash (May 2010) Chart 1: The recent downturn ended the longest streak without a 5% pullback 500 450 400 404 395 387 Trading days since 5% Pullback 371 350 300 250 200 267 256 211 189 150 100 50 50 Average 0 2/5/2018 7/15/1996 6/9/1965 3/29/1994 9/9/1959 1/10/1962 8/21/2015 7/14/1986 Capital market insights 2
Volatility should not be too worrisome; in a bull market, pullbacks and even corrections can be sharp but short-lived. After abnormally calm years, drawdowns are common; since 1945, the S&P 500 has experienced nine lowvolatility years, and all nine were followed by a decline of at least 7% at some time during the following 12 months But a drawdown does not necessarily produce a loss for the year; in six of those nine years, the annual returns were positive, and for three of those, the returns exceeded 10% During bull markets, corrections (or drawdowns of 10 to 20%) typically pass quickly; since World War II, the S&P 500 has seen 22 such moves, and on average they have resulted in market declines of 13% over four months, with full recovery historically occurring, on average, withing four months Even with this correction, the S&P 500 is merely back on trend, returning to where it was just a few months ago (see chart below) Chart 2: The early February 2018 market correction returned the S&P 500 to its long-term trend 3,000 2,800 S&P 500 2,600 2,400 2,200 Low was 2/8/17 at 2,581 2,000 1,800 Jan - 16 Feb - 16 Mar - 16 Apr - 16 May - 16 Jun - 16 Jul - 16 Aug - 16 Sep - 16 Oct - 16 Nov - 16 Dec - 16 Jan - 17 Feb - 17 Mar - 17 Apr - 17 May - 17 Jun - 17 Jul - 17 Aug - 17 Sep - 17 Oct - 17 Nov - 17 Dec - 17 Jan - 18 Capital market insights 3
This bull may have room to run, given that fundamentals remain strong. The global economy continues to enjoy a rare period of synchronized growth; all 45 countries in the Organisation for Economic Co-operation and Development (OECD) are experiencing expansion Gross domestic product in the United States accelerated in 2017 and is expected to do so again in 2018 U.S. corporate earnings rose 11% in 2017 are projected to grow 18% in 2018, helped by a reduction in the corporate tax rate (see chart below) Red flags that normally signal a market top e.g., slowing earnings, rising flows into equity funds, rotation to defensive stocks and numerous IPOs are not yet present Chart 3: Corporate earnings growth has improved 30 25 20 15 10 5 0-5 S&P 500 EAFE Earnings Growth -10 2012 2013 2014 2015 2016 2017 (est) 2018 (est) 2019 (est) Capital market insights 4
Key takeaways With the market recently completing more than a year of consecutive monthly gains, investors may have forgotten about the downside. The recent spike in volatility has remedied that, reminding them that pullbacks and corrections are a normal part of even strong bull markets. Often stocks recover quickly and continue to rise, offsetting losses suffered in the short term. Market corrections often result in lower valuations, so work with your financial advisor to consider potential buying opportunities Fundamentals remain strong, suggesting that corporate earnings may continue to rise, potentially providing more upside to this market Don t react emotionally to market volatility; stay the course, tune out the noise and focus on the long term For more help or information, contact your financial advisor. This material is not a recommendation to buy, sell, hold or roll over any asset, adopt an investment strategy, retain a specific investment manager or use a particular account type. It does not take into account the specific investment objectives, tax and financial condition or particular needs of any specific person. Investors should discuss their specific situation with their financial professional. Except where otherwise indicated, the views and opinions expressed are those of Nationwide as of the date noted, are subject to change at any time and may not come to pass. Market index performance is provided by a third-party source Nationwide deems to be reliable. Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses have been reflected. Individuals cannot invest directly in an index. MSCI EAFE Index: An unmanaged, free float-adjusted, market capitalization-weighted index that is designed to measure the performance of large-cap and mid-cap stocks in developed markets as determined by MSCI; excludes the United States and Canada. S&P 500 Index: An unmanaged, market capitalization-weighted index of 500 stocks of leading large-cap U.S. companies in leading industries; gives a broad look at the U.S. equities market and those companies stock price performance. Nationwide Funds are distributed by Nationwide Fund Distributors LLC (NFD), member FINRA, Columbus, Ohio. Nationwide Investment Services Corporation, member FINRA. Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company. 2018 Nationwide NFM-17223AO (02/18)