A History Lesson on Market Corrections
By TRG Advisors on August 8, 2024
Corrections Are Not Uncommon Occurrences
In times of uncertainty, we find it best to zoom out, look at the bigger picture, and put everything into perspective. Markets have been performing extremely well as of late, well above long-term averages. As it stands, the S&P 500 is up nearly 12% year-to-date and about 6% from its all-time high of 5,670 on July 16. Since the start of 2020, the index is up over 60%, and up 28% since the start of 2023.1 Historically, the stock market returns 7.7% per year, which has been beaten in seven of the last ten years.
Chart 1: Recent Markets Returns Have Been Above Historical Averages2
Intra-year volatility has also been quite muted relative to history. In the twenty-year period from 2002-2021, ten of those years (50% of the time) experienced a pullback of at least 10% with an average pullback of 15%. Despite those pullbacks, the stock market generated a positive return in 17 of those 20 periods.3
Intra-year market declines are not uncommon, and up until the last few weeks, we have experienced nearly zero extreme moves this year. July 24, 2024, was the first time in 356 trading days (518 calendar days) that the S&P 500 fell 2%, the third longest streak in 20 years.4
The below chart shows year-to-date daily returns up till July 17; since then, markets have experienced a wider array of returns. But visualizing this year’s daily returns before July 17 helps show just how low volatility has been relative to the previous four years.
Chart 2: The Dispersion of Returns has been Extremely Tight in 20245
Maintain a Long-Term View
The market is near a “correction” phase, which is defined as a 10% drawdown but no more than -20%, which is considered a “bear market”. Only 26% of years experience a bear market, but 64% of years see a 10% or worse drawdown and 94% of years see a 5% or worse drawdown.6 10% drawdowns are not out of the ordinary and are more likely to occur than not in any given year.
Following steep market declines, stocks perform well on a forward-looking basis. Since 1974, the S&P 500 returns over 24% on average following a correction. And when it comes to bear markets, forward returns are even greater. On average, bear markets last 1/5th of the length that bull markets do. In times of high volatility and quickly changing narratives, it is important to stick to the fundamentals and find opportunities to invest in high-quality companies at cheap relative valuations.
Chart 3: Bull Market Lengths and Returns Greatly Outsize Bear Markets7
Chart 4: Stay Invested Through the Downturn to Benefit from the Recovery8
What Happens from Here
We believe there are many factors at play, and it is too difficult to nail down the recent action to a single cause. When volatility spikes, it is important to analyze the environment and stay rational. Fundamentals and earnings are the most important factors to focus on through times of uncertainty. Markets may seem irrational in the short term, but whether it’s one week, a month, or a year from now, they will eventually reward the companies with strong fundamentals.
Our belief is that equity markets will continue to be repriced lower following the decline in bond prices due to higher interest rates and slower earnings growth across the globe. We would continue to underweight equities and fixed income (tactically) in favor of alternative investments where possible. For equities (stocks) we have been gradually shifting our exposure to more Non-U.S. based equity as well as emphasizing value equities over growth equities weighting in the portfolios. For fixed income (bonds) we will continue our overweight of a slightly lower duration, high credit quality portfolio. In the short term, we continue to watch the data and look for spots to invest in quality companies.
1 Source: FactSet. As of August 5, 2024.
2 Source: FactSet. As of August 5, 2024.
3 Source: Schwab. As of February 22, 2022.
4 Source: Bloomberg. As of July 24, 2024.
5 Source: Sherwood. As of July 17, 2024.
6 Source: The Irrelevant Investor. As of August 5, 2024.
7 Source: Schwab. As of January 24, 2022.
8 Source: MFS. As of December 31, 2023.