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 8 (27) 12 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.

Where Are We Now?

(Guggenheim Investments provides its view of the current market environment - as of 11.2019)

U.S. real gross domestic product (GDP) growth held roughly steady at 1.9 percent annualized in the third quarter versus 2.0 percent in the second quarter. The data showed a moderation in government spending and personal consumption expenditure growth, which came in at 2.9 percent annualized after an unsustainably strong 4.6 percent reading in the prior quarter. However, this was largely offset by a smaller drag from inventories and net exports.

Despite the pullback in consumer spending growth, the U.S. household sector has remained a bright spot as clouds have gathered over the global economy. The manufacturing sector has borne the brunt of the escalation in U.S.-China tariffs, while also contending with headwinds in the form of U.S. dollar appreciation and weakness in foreign demand. Beyond the U.S., the trade war has harmed global trade volumes, which contracted on a year-over-year basis in the second quarter for the first time since 2009. The global trade recession has weighed on GDP growth in economies that are particularly trade- and investment-oriented. Real GDP growth in China slowed to 6.0 percent year over year in the third quarter, the slowest pace in several decades, while German GDP barely grew in the third quarter after contracting in the second quarter.

The good news is that the manufacturing sector represents only 11.0 percent of U.S. GDP and 8.4 percent of nonfarm payrolls. We see early signs of an upturn in activity, which a tentative U.S.-China trade truce should support. The bad news is that weakness has begun to emerge in the much larger services sector. Real personal spending on services has softened over the past year, and IHS Markit Purchasing Managers Index (PMI) data points to a further slowdown in U.S. service sector activity since July. Particularly worrisome is the decline in the employment diffusion index of the services PMI, which fell to 47.5 in October, well into contraction territory. The U.S. is not alone in this respect: global PMIs also show softening labor market conditions across services as well as manufacturing.

Amid ongoing uncertainty about the economic outlook, in October the Federal Reserve (Fed) announced its third rate cut since July. However, policymakers also removed from the FOMC statement the guidance that they “will act as appropriate to sustain the expansion,” suggesting that the bar is high for further rate changes in the near term. This message has since been reinforced by the Fed’s senior leadership, who have noted that “monetary policy is in a good place.” The recent rally in stocks and bear steepening of the yield curve suggest that markets agree.

The Jury Is Still Out on Whether The Fed’s ‘Mid-Cycle’ Adjustment Has Been Successful

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 methodology2 and our latest recession update3 can be found on GuggenheimInvestments.com.

Our proprietary Recession Probability Model suggests there is 66 percent chance that a recession will begin before the fourth quarter of 2020, and an 81 percent chance that it will arrive within the next two years.

Naturally, there are substantial risks when forecasting recession timing. 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 Model4

Recession Risk is Rising

Near Term Recession Risk Has Fallen, But Expected to Rise

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 below, 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 (11.14.2019), there had been 325 days since a non-recessionary pullback of greater than 10 percent.

Ex Recession S&P 500 Corrections (>10% Decline)5

Since 1962

Ex Recession S&P 500 Corrections

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.


1 Data as of 9.30.2019. Copyright 2019 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 Visit page www.guggenheiminvestments.com/perspectives/macroeconomic-research/2019-recession-update-will-rate-cuts-be-enough.
4 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 11.14.2019. Shaded areas represent periods of recession.
5 Source: Guggenheim Investments. Data as of 11.14.2019

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