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.
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)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 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.
Where Are We Now?
(Guggenheim Investments provides its view of the current market environment - as of 5.2019)
U.S. economic growth of 3.2 percent in the first quarter of 2019 was much better than initially projected. The resilience of the economy was impressive, given headwinds that included tighter financial conditions, the government shutdown, severe weather, tax refund delays, and seasonal adjustment challenges. However, underlying growth was not as strong as it appeared: Consumption and investment spending, which together account for 85 percent of gross domestic product (GDP), grew by a meager 1.3 percent. Inflation also continued to decelerate, with the price deflator for core personal consumption expenditures (PCE) rising by 1.3 percent, the third consecutive quarterly reading below the Fed’s target.
Looking ahead, several factors that boosted growth early in 2019 should fade. Inventories, which have risen for three straight quarters, will eventually need to reverse. Similarly, big gains from trade and highway construction are unlikely to last. And the third quarter will bring fiscal battles that could rattle markets and undermine confidence: In September, Washington will have to agree on a new spending bill to avoid another government shutdown, a debt ceiling increase to avoid a technical default, and higher spending caps to avoid fiscal tightening that is baked into current law for fiscal year 2020.
Though the pace has slowed in recent months despite cycle highs in average hourly earnings gains, personal disposable income growth remains solid, and the personal saving remains elevated at 6.5 percent, which could cushion spending even if income growth slows. However, the boost to consumer spending from tax cuts has faded, and consumer confidence surveys point to a worrisome slowdown in the pace of improvement in current conditions, which typically occurs about a year before a recession. Similarly, while the labor market remains relatively strong, the rate of improvement has moderated. An uptick in labor force participation has slowed the pace of decline in the unemployment rate to just 0.3 percentage point in the past year, despite robust GDP growth of 3.2 percent over the same period. Historically, a flattening out of the unemployment rate has been a strong leading indicator of recession, especially when accompanied by a relatively flat Treasury yield curve.
Our recession forecasting tools continue to indicate that a downturn could begin as early as the first half of 2020, which we believe warrants a cautious stance with regard to risk assets.
Guggenheim’s Recession Dashboard and Recession Probability Model Point to the Next Recession in the First Half of 2020
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. At this stage, with the current U.S. expansion showing signs of aging, our focus is on projecting the timing of the next downturn.
Guggenheim has developed several tools to guide this effort. The last several expansions have shown similar patterns leading up to a recession. We have created a Recession Dashboard of six indicators that have exhibited consistent cyclical behavior, and that can be tracked relatively well in real time. These six indicators include a measure of the unemployment gap, the stance of monetary policy, the shape of the yield curve, the Leading Economic Index, changes in aggregate weekly hours worked, and changes in consumer spending. In addition to our dashboard of recession indicators, we have also developed an integrated Recession Probability Model that attempts to predict the probability of a recession over six-, 12-, and 24-month horizons. Our methodology is explained in greater detail on our Forecasting the Next Recession thought leaderhip article. 2
Taken together, our Recession Dashboard and our proprietary Recession Probability Model, point to the next recession beginning as early as the first half of 2020. Naturally, there are substantial risks that our recession date could be too early or too late. 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.
Near-Term Recession Risk Has Fallen, But Expected to Rise3
Model-Based Recession Probability
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 in the chart, 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 (5.7.2019), there had been 134 days since a non-recessionary pullback of greater than 10 percent.
Ex Recession S&P 500 Corrections (>10% Decline)4
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 Data as of 3.31.2019. Copyright 2019 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 Visit page at https://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 3.31.2019. Shaded areas represent periods of recession.
4 Source: Guggenheim Investments. Data as of 5.7.2019.
Any overviews herein are intended to be general in nature and do not constitute investment, tax, or legal advice.
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