2024 was an anomaly.
2024 was an abnormally low year in terms of volatility (see the red box in the 10-year chart below). There were only two drawdowns of 5% or more which is far below the long-run average of 4.6 times per year the market experiences these types of events.
While I don’t purport to have a crystal ball, we should expect the stock market in 2025 to experience increased volatility, especially since 2024 was relatively calm by historical standards.
In 2024 markets benefited from a combination of easing inflation, a steady interest rate environment, and strong corporate earnings. These factors helped suppress volatility, making it one of the least turbulent years in the last decade. However, this calm could set the stage for a rockier 2025 due to several possible risks.
Potential Catalysts for 2025 Volatility
- Valuation Levels: Valuation metrics are higher than they have been in years.
- Earnings Pressure: Corporate profit margins, already under strain from rising wages and costs, may face additional headwinds, sparking concerns about valuation.
- Geopolitical Risks: Global tensions, policy shifts, or unexpected conflicts could cause markets to react to unanticipated events.
- Reversion to the Mean: Historically, low-volatility periods often precede higher turbulence, as investor complacency can give way to sharp reactions to negative news.
While market volatility can be unnerving, it also creates opportunities for investors to capitalize on mispriced and/or underpriced assets.
The bottom line: Investors should expect increased volatility – which could mean a significant draw down of MORE than 5%.
It can be helpful to mentally prepare for such increased volatility so if and when it comes, we are not surprised by it and have already thought through what we may or may not do. As with so many other areas of life, being mentally prepared is a substantial part of being successful.
-Paul R. Rossi, CFA