Three charts that help explain this year’s stock market volatility
- The recent decline of the S&P 500 occurred at a historic pace
- The stock market experienced a level of volatility last seen in 1929
- For the first time since the 2008 financial crisis, the Fed cut interest rates to zero
The uncertainty created by the coronavirus pandemic has made it hard for investors to get a grip on what’s happening in the markets. There are concerns that the world economy could contract, especially with ongoing disruptions to global supply chains. Meanwhile, US unemployment has soared. From mid-March through May 2020, more than 40 million people (roughly one in four American workers) filed for unemployment benefits. And despite Congress giving the green light to a $2.2 trillion emergency relief package, experts say the US economy may have already entered a recession.
While we can’t know how the COVID Crash will unfold, there are financial reference points that can help shed light on what’s happening right now. Here are three charts focused on: 1) how the current stock market decline compares to historic drops, 2) what investors are willing to pay for government bonds, and 3) how the Fed’s interest rate policy compares to recent history. This data may help put into context the current volatility, investor anxieties, and hopefully, the state of the US economy.
The S&P 500’s fastest 30% drop ever: A snapshot of unprecedented volatility
Editor's Note: As of June 5, 2020, the S&P 500 index is actually down just about 2% year-to-date. It has rebounded quite a bit from its March 2020 low, when it was down more than 30%.
The market’s reaction to COVID-19 has been, well, vicious— even compared to some of the worst periods in investment history. The data makes it clear that market volatility in 2020 has been unprecedented. This is shown starkly by a chart comparing the S&P 500’s declines during the Great Depression, “Black Monday” (in 1987), and the 2008 financial crisis to the fall that happened during February and March 2020. Starting on Feb. 19, 2020 it took just 22 trading days for the S&P 500 (a stock index that’s seen as a general reflection of the US stock market) to drop 30%. On March 20, 2020, the index was priced nearly 32% lower than its Feb. 19 peak of 3386.
Of course, the year didn’t start out that way. At the outset, the stock market actually continued its ascent. Through Feb. 7, about 71% of companies beat earnings expectations, and strong results repeatedly powered the S&P 500 to fresh highs.
Although the S&P 500 plummeted, its journey down was not a straight line. Instead, it wavered, pushed higher during intermittent rallies and then lower again by worsening reports (e.g., school and business closures; then, state-wide orders to shelter in place). Between precipitous drops, the index was temporarily buoyed by Federal Reserve announcements and Congressional votes. So, when we examine its recent performance—between Feb. 19 and March 31, 2020—the S&P 500 has left something of a zig-zag pattern.
The saving grace is this: As fast and stunning as the market drops have been, they’ve been offset, at least a bit, by record-setting surges. For instance, on March 12, the Dow Jones Industrial Average (another major index, which tracks some of the largest and most respected companies in the US) suffered its worst day since 1987. But later that month, it also experienced its best day since 1933. And as of June 4, the Dow was down just 4.5% from the start of 2020. While we’ve seen truly historic volatility in 2020, it’s important to remember that the US stock market has recovered from every previous bear market.
It’s important to understand, a 20% fall and 20% rise won’t return investors to their starting point. For example, if a stock trading at $100 drops 20% (or $20), then its price would be $80. (That’s simple enough.) If the stock’s price then rebounds 20%, it would go up by $16, meaning its latest price would be $96. This is because percentage change calculations use the most recent price as their reference point. (In this example, 20% of $80 is $16.)
Record low government bonds: A signal of investor anxiety
In this uncertain climate, some investors have demonstrated a preference for cash, a phenomenon reflected in the rush for short-term government bonds. These bonds are also known as Treasury Bills, or “T-Bills,” and they’re considered some of the safest investments available since they’re backed by the US Treasury Department. T-Bills are typically sold in increments of $1,000. (To help finance the $2- trillion stimulus package, the Treasury Department may sell additional short-term bonds.)
Government bond yields, the return an investor expects to receive on a government bond, hit a record low in March this year, a strong indicator that investors are extremely anxious. Let’s break that down: When the stock market is performing well, investor demand for government bonds is typically lower. That’s because many investors believe they can earn higher returns through equities (aka stocks). In recent months though, with the stock market’s turbulence, many investors have piled into government bonds in the hopes of seeing less volatile movements. Since people are willing to pay more for less in return, the influx in demand has pushed down the yield.
Demand got so high, in fact, that for a time, yields on one-month and three-month T-Bills actually turned negative. Paradoxically, this means that an investor who held the bond for its full duration, or “to maturity,” would receive less money back than they initially put in. (It would be like investing $1,000 and receiving $999.96 at the end of the month.)
Negative yields are an anomaly, but they reflect the exceptional times we’re living in. Some investors are so concerned about keeping cash, or cash equivalents, that they’re willing to accept a small loss in the pursuit of financial stability.
Lowered US Interest Rates: Ensuring banks can keep moving money
When you hear a reference to the US interest rate, that usually means the Fed Funds Rate, the interest rate at which banks borrow from one another on an overnight basis. You might think of this like borrowing $20 from a friend and promising to pay it back the next day with a small amount of interest. The Fed Funds Rate also affects consumers, indirectly influencing interest rates on things like credit cards and car loans.
To help avoid disruptions in banking services and ensure that depository institutions (e.g., banks, credit unions) can keep moving money smoothly, the Fed lowered its target range for the Fed Funds Rate in mid-March to 0–0.25%. Interest rates haven’t been this low since the financial crisis in 2008, a strong sign that the economy has slowed.
Right now, we’re living through a strange and challenging time. Never before have billions of people sought shelter to stem the spread of a pandemic, and never before in its 228-year history has the New York Stock Exchange been forced to operate with all-electronic trading. (While it might seem a bit outdated, for more than two centuries, the exchange has relied on live people—traders shout out buy and sell orders, and runners shuttle information to and from processing clerks. Over time though the trading process has become increasingly computerized.) For investors, these charts paint an extreme picture of the financial situation, but they also reflect our new reality, providing some context into how the market might shift. COVID-19 has demanded an exceptional amount of patience, and it has forced historic measures in governmental policy. Keeping tabs on the evolving stimulus plan and the country’s monetary policy may help investors decide what strategy is best for them during these extraordinary times.