Strategy Insight: On Volatility

May 10, 2022
BBH Chief Investment Strategist Scott Clemons discusses recent market volatility and examines the driving forces behind the current environment. In such markets, he reminds us, patience and discipline are essential.

From the pandemic-induced lows of March 2020 through January 3 of this year, the S&P 500 index rose 120% (including dividends) without a single setback exceeding 10%. There are no straight lines in financial markets, but this prolonged rally came close. Ah, how times have changed! Through May 9, 2022, the S&P 500 is down 16% so far this year, and thousand-point swings in the Dow Jones Industrial Average have become regular occurrences. We are reminded daily that volatility is a feature of financial markets, not a bug.

The question on most investors’ minds is: Where is this volatility is coming from, and when will it go away? As much as we like for effects to have causes, volatility does not require a catalyst: It is endemic to markets. We believe that financial markets are reasonably efficient over time, but only as efficient as the participants that comprise them. To the degree that people are susceptible to irrational bouts of greed, envy, doubt, anxiety and every other human emotion, so, too, are markets. Efficiency is more like gravity than it is a stable state of affairs: Market prices trend toward an efficient reflection of value but always overshoot on the upside and the downside. Disciplined investors can take advantage of these deviations from reality.

The search for reasons for the current spate of volatility reveals a target-rich environment. As we have discussed in various webinars and commentaries, the only bull market at present is the bull market in uncertainty. Economic leadership is transitioning away from policy and back to the more fundamental driver of household spending; the future trend of inflation is unclear, as is the Federal Reserve’s aggressiveness in tightening monetary policy to combat it. To this already volatile mix, add a land war in Ukraine and a midterm election looming in the U.S. There is plenty to worry about, and it is unlikely to clear up soon.

Investors hate uncertainty, and prices reflect this. At a philosophical level, price is a wonderful concept. Prices are transparent – anyone with a smartphone can retrieve the price of a publicly quoted security on a moment’s notice. Furthermore, prices are updated continuously during a trading session, and we can all agree on the current or closing price of a security. The downside, as we’re seeing at present, is that prices are volatile.

Value has the opposite constructs. Value is not transparent or readily obtainable. It takes a lot of work to derive the fundamental value of a security, either in the public or private markets, and different analysts will almost certainly disagree over intrinsic value. Unlike price, value is characterized by little transparency, infrequent updates and widespread disagreement. Value, however, is far more durable and stable than price.

It is for this reason that our investment approach, across all asset classes, hinges on the identification of value, coupled with the patience to allow market volatility at the security level to provide an entry point at a discount to the intrinsic value of the asset.

Let’s look at a few fundamentals to illustrate the potential disconnect between price and value at the macroeconomic level. Over the past year, the S&P 500 is down 1.2%, indicating that we have given up most of last year’s rally. The nearby table outlines the usual suspects for this reversal. Compared to last year, the fed funds rate is up 77 basis points, the 10-year bond yield has risen 1.31%, and the two-year yield is up a whopping 2.56%. Inflation last year was a modest 2.6% but stood at 8.5% in the last report. No wonder the market is down.

Glass Half Full or Half Empty?
Select Macroeconomic and Market Indicators


April 30, 2021

April 30, 2022


S&P 500 Index 4,181.17 4,131.93 -1.2%
Fed Funds Rate 0.03% 0.80% 0.77%
2-Year Yield 0.16% 2.72% 2.56%
10-Year Yield 1.63% 2.94% 1.31%
CPI Inflation 2.6% 8.5% 5.9%
Labor Force 144,694 151,314 6,620
Unemployment Rate 6.0% 3.6% -2.4%
Real GDP at an Annual Rate 19,055.70 19,735.90 3.6%
Trailing 12-Month Corporate Earnings 150.28 210.95 40.4%
Trailing P/E Ratio 27.8x 19.6x -8.2x
Source: Bloomberg and BBH Analysis.

Data as of May 9, 2022
Past performance does not guarantee future results.

But perhaps the glass is half full as well. The economy has restored almost 6.7 million jobs over the past year, bringing the unemployment rate down to 3.6% – a tenth of a percent off a 50-year low. Real gross domestic product is up 3.6% over the past year, and trailing corporate earnings are up over 40%, bringing the S&P 500 P/E ratio down from 27.8x to 19.6x. Maybe things aren’t so bad after all.

The point of this is not to argue that one interpretation is more rational or correct than the other, but simply to observe that there is always fuel for the volatility of human emotion that translates into market prices, and that the turning points in this sentimental journey are unpredictable.

As a recent example, there was no rational reason for the equity market to bottom on March 23, 2020, the nadir of the last market cycle. One look at the front page of The New York Times from that dark day indicates there was little to be optimistic about. The world was closed for business, politicians were already fighting about the appropriate policy responses, and New York was building a field hospital in Central Park. And yet this day marked the bottom of the market. Equities turned higher the following day and more than doubled over the next year. Turns in investor sentiment can, and often do, happen at the most counterintuitive times.

So what is an investor to do? On one hand, you could sell or trim equity exposure and wait out this volatility from the sidelines. Leaving aside the potential tax implications for taxable investors, this approach requires two decisions: when to get out and when to get back in. You have to get both right, and as the front page of The New York Times from March 23, 2020, makes clear, the timing of re-entry is obviously only in hindsight.

Furthermore, mistiming your re-entry can be costly, as market rebounds often unfold quickly. Even with this year’s sell-off, the S&P 500 is still up 84% from the March 2020 lows. If, however, an investor waited to see the market bottom in the rearview mirror, and re-entered just a month later in April 2020, her return is only 47%. That first month of the rally made a big difference.

On the other hand, an investor could choose to stay invested and allow managers to exploit the disconnects that continue to arise between price and value. Make no mistake, this is not the most pleasant of courses. Headlines are scary, and are likely to remain so, but keep in mind that headlines are written by people whose business models rely on readership and clicks. “Stay calm and stay the course” doesn’t sell too many newspapers.

We can’t help but be reminded of the old adage that the secret of success in investing is to buy low and sell high. What this old chestnut fails to capture is that, if you’re doing it right, neither action should feel comfortable. Selling high runs the risk that the price of the asset continues to rise, and you feel like a fool for selling too early. Similarly, buying low runs the risk that prices will continue to drop.

Hence the necessity of both patience and discipline, in equal measure. Stay calm and stay the course.

Up Next
Up Next

Strategy Insight: Inflation with a European Accent

As inflation surges, BBH Chief Investment Strategist Scott Clemons discusses the reasons behind higher prices. In addition, he covers what we expect to see from inflation over the course of 2022.

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