Using history to navigate volatile markets

Markets are sending a lot of mixed signals these days. On one hand, the news cycle is dominated by geopolitical risk, stubborn inflation, and concerns about everything from AI disruption to credit stress. On the other, equities keep pushing higher, brushing off what would’ve been major catalysts for selloffs in past cycles.

So, what’s the market actually telling us, and what are investors getting wrong?

To unpack that, we spoke with Denise Chisholm, Director of Quantitative Market Strategy at Fidelity, who approaches markets through a historical lens. Using decades of data to map how different environments have played out before, she focuses less on predicting headlines, and more on what prices already reflect.

Our conversation has been edited for length and clarity.

When people talk about the biggest risks in markets right now, what do you think they’re missing?

When you say, “Where do you think the biggest risk is,” I think the implicit reaction is that it’s downside risk. I don’t think we talk enough, especially in markets, about upside risk as well—because you can get it wrong both ways.

Maybe there is more bad news, it gets worse, and stocks go down. That’s the risk people usually mean. But there’s also the risk that you get it right—and there is more bad news—but the market has already discounted it, and stocks go up anyway, and you lose out on those returns.

When you look through history, even if you correctly forecast all the things that can go bump in the night, they don’t have a very consistent impact on the equity market. We don’t have to go back very far—COVID, the 2023 banking crisis, inflation in 2022, tariffs. These were all potentially systemic, even existential events. And yet, the market was able to climb the wall of worry. So instead of trying to predict every negative event, I focus more on what the market is already discounting.

With geopolitical tensions like the Iran conflict, how should investors think about market impact—and how much of that is already priced in?

There is a risk that it’s already priced in, but one way to approach it is to look through history and try to contextualize it.

We, unfortunately, have a lot of data on geopolitical conflicts. And when you think about the long term impact of the equity market, on average, they don't really have one. If you look at returns one year after the start of a conflict going back to 1942, they’re about 8%, which is in line with historical averages.

People also tend to compare today to the 1970s or 1980s. But the data is dramatically different this time. Oil intensity has declined precipitously over time, so the same price shock is hitting a very different economy.

So instead of thinking through price, let's think through impact and look at what the impact of higher oil prices could be on either household balance sheets, or, more importantly, corporate profits. I think it would take much, much higher prices than where we are to see the stress that everybody is afraid of. To say it slightly differently, this shock might be much more absorbable than people think.

There’s a lot of concern around AI disruption and the software sector. How real is that risk?

Every technological advancement displaces jobs, going back to the industrial revolution. Workers are displaced with every technological advancement, but on net, we have always added jobs. That is not to say that the past is completely prescient and will forecast the future, and you could make the argument that it's gonna be different this time, but what if it's exactly the same? So yes, some jobs will be lost, but on net, more new jobs will be created.

In software specifically, what stands out in the data is that companies have never been more profitable: operating margins are in the 100th percentile from 1962, while valuations are in the 14th percentile. It is really rare to have a 75% gap between your ranking in terms of how profitable you are and how you are valued in the market.

So, back to your question of what has already been priced in: by this point, it's pricing in its own financial crisis, and at least on average, maybe there's less downside than you think.

More broadly, the entire technology sector has been de-rated. And historically, the cheaper technology stocks have been, the more likely they are to outperform, even if the risks people are worried about actually come to fruition and margins decline.

Also, this isn’t an earnings problem right now. Software earnings are still strong, and forward estimates are still moving higher.

What’s the biggest mistake everyday investors make in volatile markets?

The biggest risk is reacting to headlines.

On average, equities have returned about 8% historically. But the average investor earns closer to 2-3%, because they sell when news is bad and buy when news is good.

Unfortunately, for equity market investors, you have to put up with the volatility to get the returns. Nobody gets 8% returns on average for free. So you sort of have to put up with the 20% drawdowns. You can do that if you extend your time horizon.

The longer your time horizon, the more you can look through those headlines and focus on the ultimate driver of markets: corporate profits, which tends to be a little sturdier than you might think.—SY