Taking the long view on tariff-driven volatility

Within days of President Trump’s April 2 announcement of global tariffs – which shocked financial markets globally for their scale and size – the S&P 500^® Index had lost just over 12% of its value. Even more quickly, after the president authorized a 90-day pause on said tariffs (excluding China), the benchmark staged one of its most impressive one-day rallies ever.

Drawdowns are more frequent than not

The continued volatility has left many investors asking, “This isn’t normal, right?”

The answer to that question is more nuanced than might first appear. In the last 25 years or so, the S&P 500 has experienced more than a half dozen bear markets (a decline of 20% or more from recent highs), with price declines of 5% or more occurring in most calendar years – including those when the benchmark finished with positive returns.

What was unusual this time around was the speed of the sell-off. The S&P 500 dropped -4.8% on April 3, followed by a fall of -6.0% the following day. That marked only the 13^th time since 1929 that the benchmark experienced back-to-back trading days with declines of -4.5% or more.

Such large market moves in such a compressed period can make it tempting for investors to run for safety. But history suggests that impulse might not be the correct one. Volatility begets volatility, with a rise in short-term and algorithmic trading activity helping intensify intraday price swings. But stocks have often gone on to stage significant moves to the upside following these drawdowns.

Case in point, only days after the tariff-induced sell-off, the S&P 500 snapped back on April 9, rallying 9.5%. The one-day turnaround was not enough to retrace all the S&P’s losses, but it still ranks among the top 10 of one-day gains in the index’s history (Exhibit 2). Notably, the three consecutive sessions from April 7 to 9 were each among the 35 most volatile on record based on intraday highs and lows.¹

Where to from here?

Much remains unknown about the next stages of the trade war, with the potential near- and long-term investment and economic implications likewise unclear. For now, investors are weighing the potential inflationary impact of tariffs and how consumers will react to higher prices. Continually shifting trade terms also raise questions about how long tariffs will last and at what level, and how companies will adapt to the new operating environment.

Given the uncertainty, it would be prudent to expect further volatility. And while market volatility is inherently unsettling, it’s important to note that it is not necessarily a harbinger of a downward trend. In fact, significant spikes in volatility – as measured by the VIX Index – have often signaled future gains (Exhibit 3).

The potential for short periods of volatility to lead to longer-term stretches of gains shows that it has often paid to ride out the inevitable fluctuations. Furthermore, the swiftness of recent moves makes it clear that trying to time the market can cause more damage to a portfolio than market volatility itself, as illustrated in Exhibit 4.

The value of active management in volatile markets

For investors with longer-term horizons, staying in the market has ultimately paid off. This is especially the case when volatility presents an opportunity to upgrade portfolios.

As active managers, in times of significant volatility, we seek to take advantage of attractive entry points on stocks where valuation may have previously prevented our investment. We also have the latitude to look at a wider spectrum of companies, beyond the indices, to find quality business models and companies we think have the potential to outperform over the long term.

We know that a new paradigm for global trade – regardless of its ultimate form – will present both opportunities and risks, and companies with proven management teams, quality business models, competitively advantaged products, and/or strong intellectual property should hold their own. We believe this is an era when companies with tenuous business models and backward-looking, reactive strategies may fracture – but when the strongest companies can still thrive.

IMPORTANT INFORMATION

Actively managed investment portfolios are subject to the risk that the investment strategies and research process employed may fail to produce the intended results. Accordingly, a portfolio may underperform its benchmark index or other investment products with similar investment objectives.

Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.