Chartology: June 2019
In this month’s edition of “Chartology”, Director of Investment Research Chris Maxey discusses the phenomenon of drawdowns in the equity markets, and whether they are a feature or a bug of the stock market.
We’re going to take a little different tact this month. We’ve been talking about a lot of recent market trends with IPOs and share buybacks the last couple months. So we want to discuss a longer term phenomenon in the equity markets, which are drawdowns, and specifically drawdowns of greater than 10%. We want to talk about whether these are a feature or a bug of the stock market.
What you see here is the index level for the S&P 500 going back to 1945 and up through May of 2019. We started at 1945 because that really captures the post-World War II economic boom or expansionary environment. What you see is that over that time frame, the market has compounded about 11.2% on a total return basis, but one of the interesting things, is what the path looks like from point to point. In the orange shaded areas, what you see is when the S&P 500 index is at an all-time high or in a relatively shallow drawdown, what we’re terming here as between 0 and 10%. In the lighter-colored boxes or shadow, you see when the S&P 500 is down 10% or more. There are actually quite a few environments where the S&P loses more than 10%. It’s actually about 40% of the time. If we try to equate this to the number of days in the year, there are 365 calendar days, and so on about 146 of those days, the S&P 500 is going to be down more than 10%. That’s a relatively significant number.
Is this a feature or a bug of the market? In our opinion this is a feature, not a bug. Short-term drawdowns tend to mask longer term results. So over this entire time frame, despite the fact that 40% of the time we’ve been in that significant, or relatively significant drawdown, the market has still compounded at more than 11%. On any given day, it’s going to be a coin flip as to whether the market is up or down, but as we extend out our time frames to one month, one quarter, one year, five years, ten years, the likelihood that the market is going to be positive becomes higher and higher. So as we look at rolling 20 year periods, there has never been an environment where the S&P 500 has actually lost money.
So the next time you read headlines that the market is in turmoil, or you see the market being down 10, 15, 20% like it was in the fourth quarter of 2018, we want you to remind yourself that this is a feature of the market, this is not a bug. This is not a thing to be worried about. It’s a relatively common phenomenon, and drawdowns really allow us the opportunity to re-balance portfolios, take advantage of a number of different things like tax loss harvesting, and rotate into new opportunities. So we hope you found this useful.
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