Markets get jumpy again; investors should keep their nerve

So this is what all those market watchers meant when they said the stock market was quiet, too quiet.

The violent moves for stocks over the last week have been particularly jarring for investors because they'd been sailing through unusually calm trading and strong returns for more than a year. It was a return to more "normal" conditions — but much like stepping out of a soothing, warm shower on a cold winter morning.

Experts are saying even more volatility may be on the way. The market is worried about the threat of higher inflation and interest rates, and it's also concerned that stock prices have become too expensive following their huge run. Many still expect stocks to gain over time, in part because the global economy is strengthening and recently passed tax cuts should give an extra boost to corporate profits. But a drop for stocks in the near-term may well be a restorative thing.

"This pullback is simply helping to get some of the froth out of the market," said Tim Armour, chairman and CEO of Capital Group, which runs some of the world's largest mutual funds under the American Funds name. "Some volatility is a natural part of investing, and it is healthy for markets."

The nearly 8 percent drop for S&P 500 index funds from two Fridays ago through Monday was the first loss of even 5 percent in a year and a half, a record amount of time. For younger investors, this may be their first bout with market volatility.

Calm markets have become such a given that investors poured dollars into products that made money if expectations for volatility remained low. They did this by investing in the futures market for the VIX index, which measures how worried traders are about a drop in stocks, and often used borrowed money to do so.

But some of these seemingly can't-miss products blew up in the past week after volatility spiked and lost as much as 90 percent of their value. Some market watchers blame the breakdown of these esoteric investments for exacerbating volatility and accelerating Monday's sell-off in particular, when the S&P 500 lost 4.1 percent.

So, what would a return to "normal" volatility entail? For one, expect more down days for the market. Second, expect those losses to be bigger than they have been.

From the start of 2017 through January of this year, a typical down day for the S&P 500 meant a loss of 0.2 percent. Half the losses for the index over that time were more than 0.2 percent, and half were less. But over the last 20 years, a down day for S&P 500 index investors was roughly three times as bad, with a median loss of 0.6 percent.

The swings may even be more noticeable within a single day. During the calm stretch of 2017 into January, a typical day for the S&P 500 saw it drift just 0.5 percentage points from its low point to its high. On the first day of this year, for example, the S&P 500 held tight between a gain of 0.3 percent and 0.8 percent.

Over the last 20 years, though, the typical trading range was more than double that, at 1.1 percentage points. So think of a day like Election Day 2016, when the S&P 500 flipped between a loss of 0.4 percent and a gain of 0.7 percent.

One natural reaction to increased volatility is the inclination to get off the wild ride and sell. If you have a long time horizon for the investment, say a decade, the general recommendation is to resist that temptation. Stocks have historically offered some of the biggest returns over the long term for investors.

Investors who want less volatility should be in bonds, savings accounts or other investments with less risk. The trade-off is that returns over the coming decade will likely be lower.

"Stocks do go up and down, this is normal," said Roger Young, a senior financial planner at T. Rowe Price. "It is something that, if you have a long-term outlook, it shouldn't worry you too much."

Brian Armstrong, a 46-year-old in Tigard, Oregon, is thinking along those lines. He's willing to ride through the ups and downs of the stock market and isn't looking to make a flurry of moves in the short term. To scratch that itch, he plays in the cryptocurrency market, which is famous for being even more volatile than stocks.

"I hold stocks, but mine are for the long term," he said. "I'm making the conscious choice not to monitor (the stock market) on a day-to-day basis."