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 three 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 14 months.


The Deeper the Stock Market Decline, the Longer the Recovery1
Declines in the S&P 500® (Since 12.31.1945)¹

Decline % Number of Declines Average Decline % Average Length of Decline in Months Average Time to Recover in Months
5-10 77 (6) 1 1
10-20 27 (13) 4 3
20-40 8 (27) 11 14
40+ 3 (51) 22 57

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. Pullbacks above 20 percent (including all pullbacks above 40 percent), that 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 2.2018)

The performance of the global economy exceeded expectations in 2017, with growth accelerating and the expansion becoming more synchronized across countries. The initial estimate of U.S. real gross domestic product (GDP) growth came in at 2.5 percent in the fourth quarter of 2017 (Q4/Q4). We forecast a similar pace for 2018, supported by strong global momentum, supportive financial conditions, and an extra boost from tax cuts of around 0.3 percentage point. Corporate profit growth will also get a jolt from the tax bill, though some highly leveraged companies will be hurt by the new limits on interest expense deductibility.

While GDP growth has been tepid during this expansion, it has been above potential, and, there is a growing risk of running too hot. The labor market is already in the early stages of overheating, with the unemployment rate holding at a cycle low of 4.1 percent in January. We see unemployment ultimately falling to 3.5 percent by the end of 2018. While job growth continues at an unsustainable pace, wage growth has still been relatively unresponsive to declines in the unemployment rate. This could mean that the natural rate of unemployment is lower than the Fed’s current estimate of 4.6 percent, and it could also mean that there is still labor market slack left in the form of people not currently in the labor force.

The fly in the ointment has been core inflation, which remains below the Federal Reserve’s 2 percent goal on a year-over-year basis. Inflation has rebounded sequentially, however, with core CPI inflation having accelerated to a 2.5 percent annual rate in the six months ending in January.

We still see four hikes in 2018 as opposed to the Fed’s baseline of three, reflecting our expectation for a steeper drop in unemployment this year and a more hawkish Federal Open Market Committee composition. Moreover, financial conditions remain highly accommodative, and fiscal stimulus from the new tax plan will give the economy an additional boost, giving the Fed further room to raise rates. Also supporting the case for four hikes in 2018 were some of the underlying data in the Q4 2017 GDP estimate: There was very strong growth in final sales to domestic purchasers (a 4.3 percent seasonally adjusted annual rate), which shows above-potential underlying growth, as well as quarterly core PCE inflation rising to a 1.9 percent annualized rate.

Guggenheim’s Recession Dashboard and Recession Probability Model Point to the Next Recession in Late 2019 or 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 page on www.guggenheiminvestments.com.1

Taken together, our Recession Dashboard and our proprietary Recession Probability Model, point to the next recession beginning in late 2019 to mid-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 Is Low, but Longer-Term Risks Are Rising2

Model-Based Recession Probability

Longer Bull Markets Lead to Larger Corrections

Interval Since Last Non-Recessionary 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 following 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 (2.05.2018), there had been 7 days since a non-recessionary market pullback of greater than 10%.

Ex Recession S&P 500 Corrections (>10% Decline)3

Since 1962

Longer Bull Markets Lead to Larger 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, 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 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 9.30.2017. Shaded areas represent periods of recession.
3 Source: Guggenheim Investments. Data as of 2.05.2018.

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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