2. Market drawdowns are normal
Since volatility has been tepid for so long, some investors may perceive market movements in 2018 to be extreme. However, the drawdown we experienced at the end of the year is quite normal. Actually, 2017 was the extreme year.
- Maximum drawdown YTD 2018: -20%
- Maximum drawdown 2017: -3%
- Average maximum drawdown since 1928: -16%
- Median maximum drawdown since 1928: -13%
This year, investors should have some deja vu. According to Charles Schwab, the average S&P 500 drawdown in a midterm election year is -16.0%. The average 12-month gain from that trough has been +32.0%. We are now down 14.3% from the Sept. 21 high.
3. Recessions are to be expected
With the end-of-year market decline, investors have been turning more attention to the prospect of a recession on the horizon for the U.S. Recessions are defined as a fall in gross domestic product for two-consecutive quarters.
It has proven very difficult historically to predict the exact time period in which a recession will occur. Trying to time in and out of the market to avoid potential recessionary stock pullbacks has proven to be very difficult as well.
Recessions are a normal part of economic cycles. While bear markets in stocks occur more frequently, there have been eight recessions since 1960. Recessions have lasted one year on average. Over the nearly 60-year period, the economy was in recession 13% of the time. Likewise, we have had at least one recession every decade for the last five decades.
There has been a lot of discussion throughout the year about the risk of an imminent recession. Of note, many market pundits have talked about the risk of an inverted yield curve leading to a recession.
An inverted yield curve means the yield on 10-year U.S. Treasury bonds is lower than the yield on the two- year U.S. Treasury bonds. While the yield curve did not invert in 2018, it got very close, with the difference in yield hitting a low of 0.11%.
Historically, inverted yield curves have predated each U.S. recession. The problem is, the average time period between an inverted yield curve and a recession is 18 months, with a pretty wide dispersion.
Likewise, the normal frequency of recessions historically would make it likely that a recession follows nearly every event within a few years. Inverted yield curves are something to monitor. However, we do not advocate trying to time in and out of the market to avoid recessions. Instead, we support maintaining a disciplined strategic investment strategy.
Recessions Since 1960