Timeless Lessons for Volatile Times
The roller-coaster market continues. News and rumors are dominating the discussion, and no one seems to know what to really believe. This week, we wanted to focus on some timeless lessons that all investors need to know during these volatile times.
Volatility Happens
Even the best years have some bad days. Last year is a perfect example: We had a near-bear market (down close to 20%) after Liberation Day, yet stocks soared back to new highs and it was another good year for the bulls.
We all want to gain 20% a year forever, but that isn’t possible. To see the solid returns that stocks can provide in the long run, you have to withstand the inevitable volatility and bad times. Or, as Regis Philbin once said, “The stock market is fun, but sometimes very painful.”
During times like this, we like to share this chart. On average, you get one 10% correction and more than three 5% mild corrections a year. Given we just saw our first mild correction this year, it’s good to remember that it is perfectly normal to see some market jitters and volatility, as it happens most years.
Earnings Drive Long-Term Stock Gains
We get it, the headlines are quite bad, and confusion reigns. But as of now, we do not see a pending recession in the US, and by the end of 2026, it may be another solid year for investors.
One bit of good news is that earnings continue to soar, with various groups showing no major stress from a change in consumer or business demand yet. Last week, we saw various airlines report solid guidance, and AI demand has shown no signs of slowing either. In the end, S&P 500 forward 12-month earnings estimates hit another new high last week, as did profit margins. There aren’t many better indicators of what stocks may do than earnings and profit margins, which should be comforting for investors. Even though the headlines are scary, it doesn’t mean we should ignore good news when it’s there.
The Negative Sentiment Is Building, and That’s a Good Thing
Yes, the S&P 500 was recently about 9% off its late January highs, but if you looked at some sentiment indicators, you would think it’s much worse. That’s a good thing. Often, the more extreme the emotion, the greater the benefit of being contrarian. That doesn’t mean we’re calling a bottom. But greater fear means more bad news is likely already priced into the market, making an upside surprise more likely. Six years ago last week, for instance, stocks bottomed after a vicious 34% bear market during COVID, and incredibly, in some cases, we see more fear now than during a 100-day pandemic. All stocks have nearly tripled since then.
One way of showing this is that the number of bulls in the American Association of Individual Investors (AAII) has decreased a record-tying seven weeks in a row, yet another way to show just how on edge most investors really are.
Corrections and Bear Markets Happen
The S&P 500 moved into a 5% mild pullback last week. The big question now is, could it get worse? We looked at all the 5% mild pullbacks since World War II and found things moved into a correction (down 10%) about 25% of the time, and only 12.4% of the time did it move into a bear market (down 20%).
Of course, if the situation in the Middle East gets worse, the selloff could get worse as well. But with so many anticipating the worst and expecting another bear market right around the corner, it is important to keep in mind that, historically, the most likely scenario has been that stocks don’t go into a bear market, which remains our base case.
Putting 2026 into Perspective
The final lesson to always remember is that most years have scary pullbacks, yet when all is said and done, the full year usually does just fine. Last year, for instance, saw stocks down 15% in early April, and pure panic was in the air, yet in the end, stocks still gained close to 17%.
Looking at all the years since 1980, the average peak-to-trough correction was historically 14.1%, with the full year up a very solid 10.7% on average. One thing we’ve said many times is that you can do yourself a big favor by expecting stocks to see a double-digit correction each year. If it doesn’t happen, that’s great. But if it does? You’re better prepared for it.
Peeling back the onion a tad more, we found that 24 years (out of the past 46 since 1980, so more than half) were down at least double digits at some point during the year, and 14 times stocks finished the year higher. In fact, the average full-year gain over those 14 years was a very impressive 17.4%.
Double-Digit Down Years Have a Catalyst
Bad years happen, and bad things happen. 2022 was the last year we had a bad year, and we saw a terrible war, massive inflation, and a Federal Reserve (Fed) that was late to hike to slow down inflation, then was forced to aggressively hike.
Here’s the thing: Bad years have nearly always had a major catalyst. We found 12 times in history that the S&P 500 fell by double digits during the calendar year, and every time there was a major reason for the weakness. We remain optimistic that our economy may avoid a recession in 2026, and that this year won’t join this infamous list.
And zooming all the way out, here is the distribution of S&P 500 annual total returns going back to 1928. The “Christmas tree” shape of this chart tells a powerful story: Positive years have historically far outnumbered negative ones, and the range of positive outcomes has been much wider. We think this is worth keeping in mind during periods of volatility.
Will AI Lead to a Productivity Boom AND an Economic Crash?
Switching gears from the current volatility, we want to address a topic that rattled markets in late February and remains relevant: the possibility that AI could simultaneously create a productivity boom and an economic crash.
In late February, Citrini Research published a thought experiment titled “The 2028 Global Intelligence Crisis” that imagined a world in which abundant artificial intelligence led to mass displacement of workers, collapsing consumer demand, and a severe market drawdown — all while productivity growth surged. The piece went viral, and several stocks sold off meaningfully on the day it was published.
It was a fascinating piece of scenario analysis. But we believe the macro assumptions underpinning the scenario don’t hold up under scrutiny. Here’s why.
The Macro Math Doesn’t Add Up
The scenario posits surging productivity growth alongside collapsing real wages and a 10% unemployment rate, with nominal GDP still running at 5-10%. We think these assumptions are internally inconsistent.
Productivity growth is essentially the sum of real wage growth and margin expansion. Historically, during periods of above-trend productivity growth — such as 1996-2004 and 2023-24 — real wages also rose faster than in other periods. In other words, firms haven’t historically captured all of the productivity gains through margin expansion. A significant share has passed through to workers, especially in tight labor markets, creating a positive feedback loop of strong income growth, strong demand, and strong profit growth.
If nominal GDP were really running at 5-10% with deflation (as the scenario assumes), real GDP growth would have to be even higher. Workers’ compensation accounts for just over 50% of Gross Domestic Income. For corporate profits (currently less than 10% of GDI) to absorb all that growth while worker compensation fell, profits would need to surge by more than 80%. And if aggregate profits were surging at that pace, it’s hard to explain why the stock market would be in a steep drawdown, unless interest rates surged, which doesn’t square with a deflationary environment.
We also think the scenario underestimates the policy response. With the unemployment rate at 10% and persistent deflation, it’s reasonable to expect the Fed to take rates to zero (or below) and for Congress to pass some form of fiscal relief. One person’s spending is another person’s income, and a policy response of that magnitude would meaningfully alter the trajectory.
Stuff Still Has to Get Made
The Citrini piece isn’t really arguing that AI will produce goods and services in lieu of humans. Rather, it’s about taking out the middlemen, reducing friction and associated costs. But we believe that’s a good thing. If consumers pay less for intermediation, they have more money in their pockets to spend on other goods and services, which still need to be produced by someone. For businesses, cost savings from reduced friction may translate into better and more efficient processes, including further augmentation with AI tools.
We should also not underestimate the role of trust and confidence in transactional relationships. A lot of what may look like friction is actually about working with people and institutions you trust, whether it’s a team of advisors helping you sell your business or a financial advisor helping you plan for retirement.
Where the Real Risk May Lie
None of this implies things will go smoothly. We may see worker displacement, perhaps akin to the manufacturing downturn following the China shock, and we’re likely to see significant capital reallocation and rotation, which may cause volatility.
The historical parallel we think is more instructive is the pattern we’ve seen across past technology and investment booms — railroads in the 1870s, the internet in the late 1990s, housing in the mid-2000s, and energy in the 2010s. In each case, the promise of transformative technology or assets drove massive investment, stock prices soared and, ultimately, demand failed to keep up with supply. Overcapacity led to lower prices, investment spending reversed, and economic growth took a hit.
We think the real risk with AI-related job losses may lie on the other side of a potential capex bust, possibly a “jobless” recovery in which companies employ more AI tools and don’t rehire as many workers. But we don’t think that’s a 2026 story, or even necessarily a 2027 one. Right now, AI demand is clearly rising, and there may not be enough supply (including for components like memory chips and energy), which could be inflationary.
That’s essentially why we have positioned our tactical and strategic portfolios for an inflationary growth scenario, as we discussed in our 2026 Outlook: Riding the Wave. We want to ride the AI boom, but don’t want to overextend ourselves on that theme with concentrated positioning.
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The views stated in this letter are not necessarily the opinion of Cetera Wealth Services LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.
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