CIO Insights: This Is What a Normal Market Cycle Looks Like

One of our CIO Insights themes in recent quarters has been market normalization—more volatility and risk as the U.S. Federal Reserve (Fed) withdraws monetary stimulus and raises interest rates. Market downturns, including corrections (declines of 10% or more, like we experienced recently), are part of normalization. They play an important role in market cycles, addressing imbalances, reflecting the repricing of risk, and creating windows of opportunity for active managers.

Read the full Q2 2016 CIO Insights Intro:
This Is What a Normal Market Cycle Looks Like

U.S. equity investors enjoyed a historic run from 2009 to 2015—seven consecutive years of positive performance. The Fed’s historically low interest rates and enormous asset purchases produced a massive monetary tide that suppressed volatility, encouraged risk taking, and generally lifted U.S. stocks in a correlated, controlled, technical fashion.

But that tide is ebbing. Hints of change came in 2013, with the mid-year “Taper Tantrum” of rising yields and equity volatility that accompanied signs that the Fed was considering tapering its asset purchases. The Fed ended its purchases in October 2014, and started raising interest rates at the end of 2015. This was preceded and accompanied by increased stock market volatility, exacerbated by China’s economic slowdown and collapsing commodity prices. Ultimately, the changes were punctuated by the stock sell-off at the start of 2016, one of the worst beginnings to a new year in market history.

This market volatility may have seemed excessive and abnormal, but it wasn’t. We’ve been through this before. The early 2016 decline wasn’t even a particularly big correction, by historical standards. (See the graph below, which illustrates U.S. stock corrections since World War II and how the market has marched on afterward.) Markets don’t always go up. Roughly a third of the time, we have managed equity portfolios through bear market conditions. That’s what normal looks like—we just haven’t seen it for a while.

Corrections are as much a part of the market cycle as expansions—they address excesses and imbalances, and help investors focus back on fundamentals. Markets eventually find their fundamental footing and resume growing. In 2016, fundamentals matter, creating opportunities for active managers. We believe our investment teams are well positioned to pursue these opportunities, as discussed in our discipline CIO Insights this quarter.

¹ The S&P 500 Index is composed of 500 selected common stocks most of which are listed on the New York Stock Exchange. It is not an investment product available for purchase.

Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.

The opinions expressed are those of G. David MacEwen and Victor Zhang and are no guarantee of the future performance of any American Century Investments portfolio.

For educational use only. This information is not intended to serve as investment advice.