Market Volatility: Schwab’s Quick Take

U.S. stocks fell Monday as the continued spread of the delta COVID-19 variant fueled concerns of a sharper economic slowdown. The S&P 500 fell 1.6%, the Nasdaq fell 1.1%, and the Russell 2000 fell 1.5%. Small-cap stocks, value stocks, and commodities struggled as investors moved into traditionally defensive and growth-oriented areas.

U.S. stocks: COVID-19 concerns sent stocks tumbling

  • All equity sectors declined. Economically sensitive, or “cyclical,” sectors such as Energy and Financials led the market lower—Energy dragged down by sinking oil prices and Financials by a sharp decline in yields. While the traditionally “defensive” Consumer Staples sector was the best-performing sector on Monday, it still fell 0.3%.
  • The selloff came as market breadth started to weaken considerably. Since April, there has been a marked decline in the number of stocks trading above their 50-day simple moving averages (SMAs). Longer-term breadth remains stronger for the S&P 500, but only 63% of Russell 2000 stocks and 54% of Nasdaq stocks were trading above their 200-day moving average before Monday’s decline.


Global stocks: Virus case count continues to drive relative performance

  • Cyclical stocks outperformed this year when the global case count declined. Meanwhile, the defensive, lockdown-era leaders outperformed when cases climbed.
  • We believe that the global economic expansion will not be derailed by COVID-19 over the intermediate term, but in the near term it could continue to drive market volatility.
  • Diversification can help smooth volatility as the market swings back and forth, from lockdown leaders to stocks that perform better during reopening, along with changes in COVID-19 case trends. U.S. stocks and international stocks are not moving in sync with each other, which underscores the importance of global diversification.


Bond markets: Perceived safe-haven buying pulled down long-term Treasury yields

  • The 10-year Treasury yield fell below 1.2% for the first time since February.
  • Yields may trade sideways for the short term before turning likely higher by year end. While growth expectations may have peaked, the level of growth still remains high. Economic growth for the next few years is still expected to be higher than it was in the few years leading up to the pandemic. Near term, we expect 10-year Treasury yields to trade in a range of about 1.2% to 1.5%, but see the potential for a move up to 1.75% to 2% later in the year.
  • Lower-rated bonds could be at risk if the economic outlook deteriorates. Corporate bond spreads had fallen to the lowest levels since the 2008 financial crisis lows amid a strong economic outlook, but investors are now demanding higher spreads to compensate for the risk of slower economic growth.


Interest rates: A Federal Reserve rate hike is still unlikely in the near term

  • Short-term interest rates will likely remain near zero into 2023. The updated Federal Reserve “dot plot” from the June meeting pulled forward the projected first rate hike to 2023—previously, projections indicated no hikes through the end of that year. Before the Fed hikes rates, it first needs to reduce, and ultimately end, monthly bond purchases.
  • The Fed could be even more patient if growth slows more than expected. Fed Chair Jerome Powell has stressed that the economy has a long way to go before the Fed’s goals are met, so a slowdown in economic growth could mean it takes even longer than initially expected for the Fed to hike rates. 
  • Interest rates for consumer loans, such as auto loans and business loans, should remain low. Mortgage rates, which are generally tied to long-term Treasury yields, should remain low so long as long-term Treasury yields remain depressed.


Trading takeaways: Key technical support levels were challenged and volatility rose

  • Monday’s selloff left the S&P 500 with a decline greater than 1.5% for the first time since mid-May. The broad-market index lost 2.9% during the last five sessions. The technology-heavy Nasdaq Composite was hit slightly harder (-3.1%); both closed at their lowest levels since June 22nd. However, the indices remain +13% and +11% YTD, respectively.
  • Key technical support levels were threatened. The S&P 500 closed just above its 50-day simple moving average (SMA) of 4,239 while the Nasdaq Composite remained about 1% above its 50-day SMA of 14,015. 
  • Volatility rose this week. The Cboe Volatility Index (VIX) rose 22% on Monday to a two-month high and moved above its 50-, 100- and 200-day SMAs for the first time since mid-May. At its current level, the VIX is implying daily moves in the S&P 500 index of 52 points per day in either direction.
  • Equity traders should consider reducing average share size and dollar amounts per trade and exercise caution before buying the current dip, as it may not be over yet. While bargain-hunting may appear, traders should be patient and scale-in to any new equity exposure.


What should long-term investors do now?

Market volatility is unsettling, but historically not unusual. If you’ve built an appropriately diversified portfolio that matches your time horizon and risk tolerance, it’s likely the recent market drop will be a mere blip in your long-term investing plan.

However, it can be hard to do nothing when markets are rough. Given what has been happening recently, consider a few of our investing principles:

  • Build a diversified portfolio based on your tolerance for risk. It’s important to know your comfort level with temporary losses. Sometimes a market drop serves as a wake-up call that you’re not as comfortable with losses as you thought you were, or that a portfolio you assumed was appropriately diversified in fact isn’t. Schwab clients can log in and use the Schwab Portfolio Checkup tool to quickly assess whether their portfolio is still in balance with their target asset allocation. If you’re not a client, or haven’t yet established an investment plan, our investor profile questionnaire can help you determine your profile and match it to an appropriate target asset allocation.
  • Rebalance your portfolio regularly. Market changes can skew your allocation from its original target. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio, and moving the proceeds to positions that have become underweight. It’s a good idea to do this at regular intervals. Schwab clients can log in and use the Schwab Portfolio Checkup tool to identify areas of their portfolio that may have drifted away from their target asset allocation.
  • Ignore the noise. It’s hard to shift your attention when headlines and TV news are focused on the market drop. However, markets historically have fluctuated and recovered. It’s important to stay focused on your plan and track progress toward your goal, not short-term performance.

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Schwab Center for Financial Research