Putting Pullbacks in Perspective

Market pullbacks can be unnerving. That is why investors should make a plan with their financial advisors that addresses pullbacks and is informed by historical perspective, not emotion.

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Pullbacks & Bouncebacks

We can gain important perspective on market pullbacks by considering post-World War II declines in the S&P 500® Index. The majority of declines fall within the 5-10 percent range with an average recovery time of approximately one month, while declines between 10-20 percent have an average recovery period of approximately four months. Pullbacks within these ranges are not uncommon, occurring frequently during the normal market cycle. While they can be emotionally unnerving, they will not generally undermine a well-diversified portfolio and are not necessarily signals for panic. Even more severe pullbacks of 20-40 percent registered an average recovery period of only 15 months.



 

The Deeper the Stock Market Decline, the Longer the Recovery1
Declines in the S&P 500® (Since 12.31.1945)

Decline % Number of Declines Average Decline % Average Length of Decline in Months Average Time to Recover in Months
5-10 80 (7) 1 1
10-20 29 (14) 4 4
20-40 9 (28) 11 15
40+ 3 (51) 23 58

In contrast, pullbacks of 40 percent or more, while occurring much less frequently, post an average recovery time of 58 months and can potentially compromise an investor’s financial plan. Pullbacks above 20 percent (including all pullbacks above 40 percent), which have registered the longest recovery periods, have been associated with economic recessions. When evaluating a market pullback, the probability of a recession is a key insight to consider when determining whether or not to reduce equity exposure.

While recessions are readily identifiable in hindsight, prospectively they can be difficult to spot. This makes access to reliable market analysis all the more important when determining the probability of a recession.

While recessions are readily identifiable in hindsight, prospectively they can be difficult to spot. This makes access to reliable market analysis all the more important when determining the probability of a recession.

Where Are We Now?

(Guggenheim Investments provides its view of the current market environment - as of 8.2020)

We do not expect a genuine recovery will be possible until a vaccine has been developed, tested, approved, produced, and administered across the globe. In the meantime, keeping the infection rate in check will require social distancing measures that stymie economic activity. Indeed, the premature easing of lockdowns and lax adherence to social distancing guidelines has resulted in a  resurgence of new infections in the United States, reflecting the combination of millions of cases and limited testing and tracing capabilities. The result has been a stalling out of the recovery, with some measures of employment and spending even showing renewed declines in July. Recent trends do not bode well for the fall, when the start of the school year will boost social interactions and the return of flu season will strain healthcare capacity.

Joblessness has surged, with the fall in U.S. employment in April alone representing a 40 standard deviation shock, erasing all the jobs gains of the preceding 21 years. Rehiring activity turned the labor market tide in May and June, but as personal, small business, and corporate bankruptcies mount, permanent damage is being done to the productive capacity of the economy, which will stunt the recovery. Real gross domestic product (GDP) decreased at an annual rate of 32.9 percent in the second quarter of 2020, according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 5.0 percent.

Importantly, the policy response has been swift and aggressive, which has cushioned the downside for the economy and especially for markets. The U.S. budget deficit could approach 25 percent of GDP, the highest since World War II, and the Federal Reserve has promised to use all available tools, including powerful new emergency credit market facilities, to support the recovery. But even this policy response cannot make consumers spend or businesses invest amid staggering uncertainty. Moreover, future rounds of fiscal stimulus will be needed to avoid a series of fiscal cliffs as temporary measures expire. These will be more politically contentious, especially with the November election approaching, social unrest increasing and markets cheering sequential improvement in the economic data. And as the events of the global financial crisis and the ensuing European debt crisis illustrated, the persistence of macro stress means the risk of a systemic credit event is elevated. We are watching developments in emerging markets particularly closely.

The Coronavirus Has Pushed the Economy into Recession

The business cycle is one of the most important drivers of investment performance. It is therefore critical for investors to have a well-informed view on the business cycle so portfolio allocations can be adjusted accordingly. After a quick and deep recession, our focus has pivoted to understanding how long and how durable the recovery will be.

Guggenheim has developed several tools to guide this effort. Our Recession Probability Model attempts to predict the probability of a recession over six-, 12-, and 24-month horizons. As of the second quarter, the model points to a declining, but still somewhat elevated, risk of recession. This indicates that the economy is on a path to recovery, but that recovery is fragile and could be disrupted by health policy failures or a drop in fiscal policy support. Our methodology2 can be found on Guggenheiminvestments.com.

Naturally, there are substantial risks when forecasting the business cycle. Nevertheless, we believe that successful investing requires a roadmap, as with any other endeavor. Our investment team uses this roadmap to help guide our portfolio management decisions, in order to seek superior risk-adjusted performance over time and across cycles.

Recession Probability Model3

recession-probability-model-1.jpg

Interval Since Last Pullback

While there is a relationship between the days since the end of the last correction and the magnitude of pullback, as shown on the following page, the majority of pullbacks during non-recessionary periods registered declines under 20 percent. As we discussed earlier, pullbacks falling within the 5–20 percent range historically experience recovery periods of one to four months. These are not periods typically associated with severe economic deterioration, and do not necessarily represent a signal to reduce equity exposure. As of the date of this analysis (8.7.2020), there had been 136 days since a non-recessionary pullback of greater than 10 percent.

Ex Recession S&P 500 Corrections (>10% Decline)4

Since 1962

Ex-Recession-S-P-500-Corrections-(1).jpg
 

Putting Pullbacks in Perspective

Pullbacks are often not a time to panic and should rather be used as a reason to analyze and assess. Under certain circumstances, it may even be the case that a pullback represents an attractive buying opportunity for certain portfolios. The benefit of gaining reliable market and economic perspective is essential in preparing for market pullbacks. Rather than act on emotion, it’s important to put these events in context to determine what they mean.

Working with your financial advisor, you may then better assess any potential impact on your portfolio and implement a proper course of action, if any is necessary, that is in line with your investment objectives.

To learn more, speak to your financial advisor about Guggenheim Investments’ timely insights and thought leadership.

To learn more, speak to your financial advisor about Guggenheim Investments’ timely insights and thought leadership.

 

1 Data as of 6.30.2020. Copyright 2020 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All rights reserved. See NDR disclaimer at https://www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo.
2 Visit page www.guggenheiminvestments.com/perspectives/macroeconomic-research/forecasting-the-next-recession.
3 Hypothetical Illustration. The Recession Probability Model is a new model with no prior history of forecasting recessions. Its future accuracy cannot be guaranteed. Actual results may vary significantly from the results shown. This illustration is not representative of any Guggenheim Investments product. Source: Haver Analytics, Bloomberg, Guggenheim Investments. Data as of 6.30.2020. Shaded areas represent periods of recession.
4 Source: Guggenheim Investments. Data as of 8.7.2020.

Any overviews herein are intended to be general in nature and do not constitute investment, tax, or legal advice.

This information is subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security or strategy. There can be no assurance that any investment product will achieve its investment objective(s). There are risks associated with investing, including the entire loss of principal invested. Investing involves market risk. The investment return and principal value of any investment product will fluctuate with changes in market conditions.

Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC. Securities offered through Guggenheim Funds Distributors, LLC. Guggenheim Funds Distributors, LLC is affiliated with Guggenheim Partners, LLC.



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