U.S. Stock Market History: A Look at Drawdowns and the Economy

Capital market update: Volatility persists — Historical context for investors

December 20, 2018

The overall capital market landscape remained turbulent on Thursday, December 20, with major domestic and international indices marking new lows for 2018. The S&P 500 closed at its lowest level since September 2017 and is now down 7.7 percent for the calendar year. Today’s concerns started with follow-on selling from yesterday’s Federal Reserve (Fed) decision to raise interest rates (please ask your Advisor if you would like a copy of our coverage of yesterday’s events) and finished with angst regarding a potential government shutdown ahead of an apparent key Senate vote scheduled for 12:00 p.m. (eastern) on Friday, December 21.

As selling intensified on what was a high volume day, the NASDAQ Composite, a popular index associated with the Technology industry, approached a 20 percent decline from its August peak, with the 20 percent threshold marking vaunted “bear market” territory. International equities, both developed and emerging, have retreated into bear territory, as have U.S. small-cap stocks. Index declines from peak price to trough price, or “drawdowns,” have also extended into commodities, currencies, riskier parts of the bond market and other asset classes.

While we have already experienced considerable market volatility over the last three months, with an especially acute move lower in risk assets since early December, we want to remind investors how common moves like these have been in recent market history. Many market observers associate drawdowns with recessions, wars or other significant events that can transcend finance. Thus, when market activity similar to what we’ve been experiencing occurs, some investors wrongly conclude that current volatility portends more.

While no one can definitively know what tomorrow holds, and of course past is not always a prelude, we find historical context helpful when assessing asset prices’ prospects. Looking at annual S&P 500 returns since 1965, over the course of an average calendar year, the S&P 500 experiences a fall in prices, or drawdown, from peak-to-trough of over 13.6 percent, including this year’s drawdown. Further, over that same time span (54 years), the S&P 500 averaged a worse than 15 percent intra-year decline almost one-third of the time, and a worse than 20 percent decline almost one year out of every seven. Thus, the price action we are seeing thus far is consistent with historical experience — just not “recent” historical experience. 

Source: U.S. Bank Asset Management Group analysis, Bloomberg. *2018 through 12/20/18.

Without question, the market response to recessions is considerably worse. When looking at drawdowns associated with recessions since 1965, one sees considerable losses in terms of both magnitude (average drawdown of 38.98 percent) and length (average length of peak-to-trough price of 354 trading sessions, or over two years given 252 trading days/year).

Source: U.S. Bank Asset Management Group analysis, Bloomberg.

Our base case scenario does not anticipate a recession or significant enough of an economic growth decline that would trigger the types of asset responses one finds. While we have noted a decline in global growth trends within our proprietary data checks, they are not signaling a deep slowdown, particularly in the United States. This leads us to maintain our balanced assessment of risks for stocks relative to bonds. Despite the recent declines, we recommend maintaining your normal allocations to stocks based on your portfolio objectives and risk tolerance. Of course, trends can change in both directions and we will keep you posted on our readings from here.

We are fond of the saying “mental capital trumps financial capital.” Without question, market volatility can take a toll on investor patience, particularly with the range of issues enveloping the current narrative. Our role is to help increase your odds of financial success, and to that end, we are here to answer any questions you may have about how current and potential market action may impact you. Hopefully, the historical context provided herein contextualizes recent market volatility as normal. Please do not hesitate to let us know how we can help and thank you for your trust.

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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank in any way.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. Indexes mentioned are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The NASDAQ Composite Index is a market-capitalization weighted average of roughly 5,000 stocks that are electronically traded in the NASDAQ market.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Stocks of small-capitalization companies involve substantial risk. These stocks historically have experienced greater price volatility than stocks of larger companies and may be expected to do so in the future. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors.