Understanding Market Volatility in Today’s Investment Landscape
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Foreword: The Price of Investing
By Morgan Housel
The stock market represents a powerful opportunity for wealth generation. For instance, an investment in the S&P 500 made in 1925 has appreciated to $1,285 today, adjusted for inflation.
Historically, the idea that everyday Americans could tap into the market was unimaginable. In 1929, only 5% of U.S. households owned stocks, compared to over 60% today. Many investors now stand to benefit richly from their stakes in American enterprises.
Yet, this optimistic narrative cannot end here.
Let’s consider a fundamental economic principle: everything valuable comes with a cost. In personal finance, this translates to the necessity of acknowledging the price you must pay.
Investing successfully requires commitment, but the “currency” needed isn’t just cash. Instead, the real expenses are often measured in volatility, fear, uncertainty, and regret. These emotional challenges are typically invisible until you’re faced with them directly.
For example, if your goal is an 11% annual return over 30 years to ensure a comfortable retirement, it should be clear that this reward is not without its costs. During the remarkable 1,200-fold increase in stock market values, significant drawdowns were common:
- Stocks suffered drops of at least 10% more than 100 times, approximately once every 11 months.
- They retreated 15% at least 40 times, or about once every two years.
- Furthermore, they plunged more than 20% on 23 occasions, roughly every four years.
- On 10 occasions, the market experienced declines greater than 30%.
- Lastly, it has lost more than half its value three different times.
This period of extraordinary wealth accumulation came with a persistent influx of volatility and fear.
Here’s the crucial point: market volatility is not just typical; it is the price of admission.
The potential for strong long-term returns stems directly from the inherent unpredictability of short-term returns. If stability is your priority, investing in cash or bonds will yield lower returns but also less stress.
The root cause of many investing challenges often lies in misinterpreting market volatility. Investors frequently mistake it for a sign of error rather than recognizing it as the essential cost associated with investing.
Consider this analogy:
Receiving a $100 speeding ticket signifies a fine; it indicates a wrongdoing that necessitates correction.
Conversely, if I take my family out to dinner and the bill totals $100, that is a fee; it’s simply the cost of enjoying a meal. I would readily pay that again without regret.
In most scenarios, market volatility represents a fee rather than a fine.
Experiencing volatility does not indicate failure. It is the necessary toll for the opportunity to achieve superior long-term returns. The best investors are distinguished by their understanding of this cost of admission and their willingness to embrace it.
Market Environment Overview
The Nasdaq has declined over 10% since its peak in December, officially entering correction territory, while the S&P 500 is down more than 9%. This downturn extends beyond the tech sector, affecting the entire market.
Investor anxiety is palpable. Recently, investment bank Citi (NYSE: C) downgraded U.S. stocks to a neutral stance, cautioning that “U.S. exceptionalism is at least pausing.” Compounding the unpredictability, Federal Reserve Chair Jerome Powell has hinted that anticipated rate cuts may not materialize any time soon.
As uncertainty escalates and economic optimism declines, market volatility is on the rise. The VIX, often labeled Wall Street’s “fear gauge,” has surged by 60% this year, reflecting increasing investor concern as the need for government support appears to diminish.
Against this backdrop, we present a thorough toolkit designed to aid investors navigating this volatile environment while preparing their portfolios for potential shifts. The toolkit includes:
- An overview of the principal risks currently threatening the market and their underlying causes.
- Actions The Motley Fool is implementing today to address uncertainties across its offerings.
- A five-part checklist outlining practical steps long-term investors can take now to brace for a potential downturn.
As always, we encourage readers to stay informed and remember we are here to assist you.
Inside this report:
Economic Factors and Tariffs Create Market Fluctuations
Concerns surrounding the Trump administration’s economic policies are significantly influencing the current market decline. Issues such as trade policies, fluctuating tariffs, rising unemployment, and public statements hinting at impending economic instability have left investors on edge. The fact that 383 S&P 500 companies cited tariffs in their latest earnings calls underscores the pervasive unease.
Tariffs, which act as taxes on imports, increase costs for businesses dependent on foreign products. Companies face two potential responses: they can either absorb the additional costs or pass them on to consumers.
This pressure is already becoming evident. Major retailers like Best Buy (NYSE: BBY) and Target (NYSE: TGT) have lowered sales forecasts, warning that price increases on essential items, including groceries and electronic goods, are forthcoming.
Delta
Delta and American Airlines Cut Profit Forecast Amid Economic Woes
(NYSE: DAL) and American Airlines (NASDAQ: AAL) have revised their profit outlooks downward, highlighting concerns that ongoing economic uncertainty could reduce travel demand.
Inflationary Pressures and Trade Wars
Critics warn that increasing tariffs are likely inflationary. Warren Buffett recently characterized these tariffs as “an act of war, to some degree.” Similarly, Carlyle CEO Harvey Schwartz stated that trade wars have “sustainably inflationary” repercussions.
The economic impact is evidenced by recent data:
- Consumer prices rose 2.8% annually in February, remaining significantly above the Federal Reserve’s target of 2%.
- Economists suggest that the construction of the administration’s trade policies translates to a $130 billion annual tax increase on Americans, equating to approximately $1,000 in extra costs per household.
This growing pessimism isn’t confined to executives; it disconnects with average Americans as well.
Consumer confidence fell sharply in February, marking the largest monthly decrease since August 2021. Surveys indicated expectations for inflation to escalate by 6% in the coming year. Given that nearly 70% of gross domestic product (GDP) relies on consumer spending, this trend is troubling. Should households cut back on expenditures, growth might decelerate, raising the threat of stagflation—characterized by stagnant economic growth coupled with persistent inflation.
Investor Sentiment Shifts
Market conditions may appear bleak, but it’s crucial to acknowledge how stretched equity valuations were at the beginning of 2025.
Investor sentiment was notably optimistic at the close of 2024. The S&P 500 Shiller CAPE Ratio, which adjusts prices in relation to earnings over an extended period, was 37.1 in December 2024—its third-highest level ever, following the dot-com bubble and the stimulus-driven surge post-pandemic.
Investor enthusiasm persisted into 2025, with the Buffett Indicator—comparing total U.S. stock market capitalization to GDP—reaching a staggering 207% in February, surpassing the November 2021 peak of 195.6%. Statistically, when this ratio exceeds 150%, anticipated stock market returns weaken. Buffett’s response included holding over $330 billion in cash and Treasuries instead of acquiring additional equities through Berkshire Hathaway (NYSE: BRK.B).
At its peak, the S&P 500 traded at trailing operating earnings ratios between 25 and 26, while its GAAP price-to-earnings ratios exceeded 29—similar to periods preceding the dot-com market collapse. Though history doesn’t repeat, it often reflects similar patterns. Extended bull markets often culminate in volatile corrections.
Potential Economic Downturns Ahead
The Atlanta Federal Reserve’s GDPNow model foresees a contraction of around 2% in the first quarter of 2025, after experiencing 2.3% growth in the last quarter of 2024. Moreover, JPMorgan Chase (NYSE: JPM) economists recently increased the likelihood of a recession in 2025 to 40%. If a slowdown occurs, recession risks heighten, potentially leading to further declines in the stock market.
Typically, the economy and stock market do not move simultaneously. However, historical trends show that when economic growth falters, stock performance often suffers—especially when prevailing optimism is already integrated into valuations.
In the last three recessions, the S&P 500 witnessed an average decline of 38.7%. A similar contraction can remain a substantive risk should economic conditions deteriorate.
Returns as of March 11, 2025
Understanding Market Risks
Market downturns do not affect stocks uniformly. For instance, during the 2022 pullback, the S&P 500 Growth Index declined by 30.1%, while the Value Index fared relatively better with only a 7.4% drop. Historical patterns suggest that high-growth companies could experience more substantial losses if conditions worsen.
The current market is highly concentrated. The top 10 stocks now comprise nearly 40% of the S&P 500’s aggregate value, significantly surpassing the 27% concentration before the dot-com bust or the 23% leading up to the Great Financial Crisis. If these major stocks falter, they could drag the wider market down.
This concentration is largely due to inflated valuations, as underscored in the following table, which presents why stocks dubbed the “Magnificent 7” could be vulnerable:
Data as of March 11, 2025
Peter Lynch famously said that “the P/E ratio of any company that’s fairly priced will equal its growth rate,” implying that a P/E-to-growth (PEG) ratio of 1 is ideal. Quality growth stocks might justifiably reach ratios up to 1.5, yet some current numbers appear excessively high—especially in the context of potential earnings deceleration during a recession. If a trade war leads to an economic downturn, these Magnificent 7 stocks could lose over 20% of their value.
Historical Perspective on Market Behavior
Navigating market volatility can be challenging for investors. Understanding historical trends can guide decision-making and prepare for potential future volatility.
The S&P 500’s Historic Resilience and Investment Strategies
Over the past 75 years, the S&P 500 has typically seen declines of about 10% from its peaks approximately once each year. Remarkably, it has recovered every time, reaching even higher highs with consistency. While recovery may take a few months or even a couple of years, a diversified portfolio of U.S. stocks has shown incredible resilience since World War II’s conclusion.
This resilience has translated into substantial wealth for investors who remain committed during downturns. As Morgan Housel aptly noted, “Most of the money you make in a bull market actually comes from what you did in the bear market.”
Understanding Market Resilience and Risks
However, it’s essential to note that the stock market’s resilience applies mainly to a diversified collection like the S&P 500. This cannot be said for individual stocks. Research indicates that around 40% of all companies over the last 45 years have experienced declines greater than 70% from their peak prices—and have never rebounded.
Investors who participated in the COVID-19 boom may recognize this trend from recent experiences. Stocks surged after the pandemic but faced a downturn during the 2022 interest rate hikes and banking sector instability. Many once-prominent stocks now lag significantly behind their prior highs, even as the market generally followed its historical trajectory, rebounding to new all-time records through last month.
Navigating the Markets: Strategic Principles
While external market conditions remain unpredictable, investors can control their reactions and preparations. Understanding the risks, setting realistic expectations, and maintaining focus on long-term fundamentals will be crucial for what lies ahead.
After three decades at The Motley Fool, we have formulated core investment principles that guide long-term success. There are no guarantees in investing; however, we recommend adhering to these tenets in both bull and bear markets:
- Invest only capital you don’t need for the next 3 to 5 years.
- Maintain a diversified portfolio of 25 or more Fool recommendations.
- Hold stocks for an average of at least 5 years—think like an owner, not a trader.
- Invest regularly, regardless of market conditions.
- Stay the course through market volatility.
- Prepare for stocks to fluctuate 20% to 50% or more regularly.
- Understand that 80% of gains typically come from 20% of your stocks.
- Allow your portfolio’s winners to continue performing well.
- Aim for long-term returns.
- Use cash positions for stability and opportunities.
Investor Actions in Today’s Market
With historical insights and guiding principles in hand, here are the strategies our investors are currently following as they assess their portfolios.
Maintain Investment Commitment
We believe in staying invested, regardless of market swings. Our analysts continue to provide stock recommendations, and we actively manage our portfolios by purchasing new stocks. While we may make adjustments to specific positions, we prioritize keeping our investments in the market—since time is our most significant asset, and accurately timing the market is virtually impossible. By resisting the urge to sell during turbulent periods, investors can experience the benefits of staying invested, smoothing out year-to-year volatility into long-term positive returns:
Enhance Portfolio Diversification
For those with portfolios concentrated in volatile growth stocks, consider integrating stable, robust companies with lower volatility. For instance, in Stock Advisor, our recent recommendations for healthcare leaders include GE HealthCare (NASDAQ: GEHC) and Novo Nordisk (NYSE: NVO), both designated as “Cautious” by our Quant analyst team. While we appreciate strong growth companies, adding stability is beneficial, especially during market turbulence.
Monitor Large Positions
Be attentive to investments that represent over 15% of your portfolio. For any stock, even those of excellent companies, ensure confidence in their long-term viability. Consider how you would react if a stock’s value dropped by 25% from its current level.
For example, in the Everlasting Portfolio, we adjusted our stake in Arista Networks (NYSE: ANET) from 17% to a more manageable 10%. While we continue to support our investment in Arista, its recent valuation escalated beyond comfortable limits. This adjustment helped balance the risk profile for our $21 million Fool real-money portfolio.
Consider Cash for Flexibility
Assess whether you have cash reserves to increase your portfolio’s flexibility during uncertain times. Consider maintaining a baseline of 5% to 10% cash, adjusting based on your risk tolerance and portfolio construction. The greater the proportion of high-growth, volatile stocks, the more cash you may wish to keep accessible. In the Everlasting Portfolio, we now hold around 12% cash, up from 10% several months ago.
Corrections, drawdowns, and bear markets are unavoidable features of the capitalist system. However, we can learn to traverse these challenges effectively and even leverage them to our advantage.
For more insights, download our printable PDF checklist detailing five essential steps to prepare for market volatility.
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Randi Zuckerberg serves on The Motley Fool’s board of directors. Other board members include John Mackey, former CEO of Whole Foods Market, and executives from Alphabet and Citigroup. The Motley Fool holds positions in and recommends various companies, including Alphabet, Amazon, and Berkshire Hathaway, among others.
The views and opinions expressed herein do not necessarily reflect those of Nasdaq, Inc.
