Over the last few weeks, a general feeling of anxiety has emerged within the stock market. Stock prices have come under pressure, and the volatility Index (VIX), widely known as the ‘fear gauge,’ has jumped to one of its highest levels since the Fall of 2022. As of Tuesday’s close (3/11), the large-cap U.S. stocks of the S&P 500 have declined by -9.23% from an all-time high reached on February 19th. While the current drawdown represents the largest selloff since last summer, it remains reasonably tame relative to many selloffs in the past.  

Trade policy uncertainty has been among the major catalysts for the recent market swings. Most market observers had viewed the threat of tariffs as more of a negotiating tactic, and that when push came to shove, the Trump administration would not risk the current economic momentum. The growing list of tariff announcements, delays, retaliations, and further escalations appears to have proven that view incorrect. In an interview with Fox News over the weekend, the President declined to rule out the possibility of a recession, reinforcing concerns that there may be some pain ahead.

The situation has been evolving so quickly that it’s difficult to keep up. As of now, we seem to be very far away from any resolution. While a swift end to this saga is possible, it makes sense for investors to strap in and mentally prepare for a bumpy ride ahead. While riding out a volatile period is uncomfortable for anyone, it’s generally easier for a diversified investor. Unfortunately, the market environment over the last two years has not encouraged diversification.  

The large-cap stocks of the S&P 500 have seemed like the only show in town throughout 2023 and 2024. Much of that success is owed to a handful of exceptionally large and fast-growing companies, collectively known as the Magnificent 7⁽¹⁾. After such an extended period of leading the market higher, many investors have asked themselves: Why bother owning anything else?

The temptation to chase recent performance is a challenge for many. When the best performers remain at the top for an extended period, it becomes difficult to imagine the future playing out any differently. If that outperformance is fueled in part by rising valuations, as was the case for U.S. stocks in recent years, that outperformance becomes less likely to persist. Like gravity, ‘mean reversion’ is a powerful force that eventually pulls valuations toward their historical norm.  

The chart below provides a clear example of why it is so important to resist the urge to chase performance. The relative return for U.S. vs. non-U.S. stocks has been significant so far this year. Investors who moved to concentrate more in the U.S. would be feeling the impact of the volatility much more intensely.

Source: Morningstar Direct. Data from 1/1/2025 to 3/10/2025. Returns are cumulative. U.S. Stocks represented by the Russell 3000 Index, International stocks by the MSCI ACWI Ex US, Bonds by the Bloomberg Aggregate Bond Index, Cash by the Bloomberg 1-3m Treasury Bill index.

To a lesser degree, the same can be said for an investor who ditched their bonds for cash. Bonds are one of the best diversifiers of stock market risk. When stocks come under pressure, bond prices tend to rise. Cash on the other hand generally remains static. As we can see above, the return on bonds has more than tripled that of cash so far this year.

Ultimately, it’s impossible to tell how long this bout of market volatility will last or how low stock prices might dip. It’s important to remember that while the catalyst may change from one period to the next, volatility is a normal and healthy feature of the stock market. The key for investors is to stay the course and not make dramatic portfolio changes based on short-term news flow. A Diversified portfolio puts investors in the best position to do this.

(1) The Magnificent 7 group of stocks includes: Apple, Amazon, Microsoft, Alphabet, Meta, Tesla, and Nvidia

Source: MarketWatch

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