Putting Pullbacks in Perspective
Market pullbacks can be unnerving. That is why investors should have a plan for managing pullbacks that is informed by historical perspective, not emotion.
Pullbacks & Bouncebacks
We can gain perspective by considering post-World War II declines in the S&P 500® Index. When we do, we see that the majority of declines fall within the 5-10 percent range with an average recovery time of approximately one month. Declines between 10-20 percent occurred about every three years with 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 of only 14 months.
The Deeper the Stock Market Decline, the Longer the Recovery1
Declines in the S&P 500® (Since 12.31.1945)¹
||Number of Declines
||Average Decline %
||Average Length of Decline in Months
||Average Time to Recover in Months
In contrast, pullbacks of 40 percent or more, while occurring much less frequently, post an average recovery time of 57 months and can potentially compromise an investor’s financial plan. These data suggest that investors’ level of concern and willingness to reduce market exposure should increase when the probability of severe pullbacks increases. Recognizing this, investors then need to ask if severe market pullbacks, which are typically followed by long recovery periods, share anything in common.
Those pullbacks above 20 percent (including all pullbacks above 40 percent), which have registered the longest recovery periods, have been associated with economic recessions. So, when evaluating a potential 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.
Where Are We Now?
Guggenheim Investments provides its view of the current market environment (as of 10.2017)
Equity and fixed-income markets continued their strong performance into the fall, as spreads for most fixedincome sectors tightened further, and the stock market hit new highs. Year-to-date, the Dow Jones Industrial Average and the S&P 500 index are up 18.5 percent and 14.5 percent, respectively. Market performance reflects a number of important dynamics, including strong corporate earnings, accelerating economic growth, still-accommodative monetary policy, and robust business and consumer confidence.
The U.S. economy continues to expand at an above-trend pace. Real gross domestic product (GDP) grew at an annualized rate of 3.0 percent in the third quarter, despite the major hurricanes that likely subtracted around 1 percentage point from growth. We expect fourth quarter growth to be around 3 percent, supported by strong momentum in consumer spending, continued acceleration in business investment, and rebuilding activity in the wake of recent storms. Assuming no major geopolitical or other unforeseen shocks, we expect the U.S. economy will grow by between 2.0–2.5 percent in real terms in 2018, supported by a strong labor market at home, a synchronized upswing in the global economy, and favorable financial conditions. We see potential upside to 2018 growth in the event tax cuts pass in Washington.
Economic and financial conditions are supportive enough for the Fed to continue to resume a quarterly pattern of rate increases in December. Four hikes in 2018 would be a much faster pace than the market is currently pricing in, and we expect the result to be a bear flattening of the Treasury yield curve. We also will begin to start seeing the effects of balance sheet normalization. The Fed announced in September 2017 that it would allow a maximum of $4 billion in Agency debt and mortgage-backed securities (MBS) and $6 billion in Treasurys to mature on a monthly basis starting in October 2017. The monthly cap will gradually rise to reach a maximum of $20 billion for MBS and $30 billion for Treasurys. According to Fed research, quantitative easing (QE) programs depressed the 10-year Treasury term premium by approximately 100 basis points. Theoretically, unwinding QE should remove that source of downward pressure on term premiums, although this will take place only gradually due to the slow balance sheet runoff.
Exhibit 1: Strong Growth Momentum in the Leading Economic Index2
While we do not expect the normalization of monetary policy to cause a sharp repricing in securities markets, it is important to consider the combined effect of slowly rising short-term rates and term premiums on companies. An increase in term premiums in the Treasury market will likely raise borrowing costs for investment-grade companies, in turn raising costs for high-yield companies as well.
The Conference Board’s Leading Economic Index (LEI) declined 0.2% in September, following twelve months of positive monthly gains. The year-over-rate remained robust at 4.0%. Since 1962, recessions have typically been preceded by a year-over-year decline in the LEI readings (although not every such contraction in LEI results in a recession—see Exhibit 1). The LEI tracks 10 key indicators, such as employment data, manufacturers’ orders, building permits, interest rate levels and financial market performance. In announcing the latest release, the Conference Board pointed out that the slight September dip was due to the temporary impact of the recent hurricanes, particularly in labor markets and residential construction. Outside of these sectors, the majority of the LEI components continued to contribute positively.3
While there is a relationship between the days since the end of the last correction and the magnitude of a pullback (see Exhibit 2), 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.3 These are not periods typically associated with severe economic deterioration, and do not necessarily represent a signal to reduce equity exposure.
Exhibit 2: Longer Bull Markets Lead to Larger Corrections3
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, who has access to Guggenheim Investments’ timely insights and thought leadership.
1 Copyright 2017 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers, refer to www.ndr.com/vendorinfo.
2 Source: Bloomberg, Guggenheim Investments. Data as of 9.30.2017.
3 Source: Bloomberg, Guggenheim Investments. Data as of 10.27.2017. 2 Indicates 645 days since a pullback of greater than 10%.
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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