When the market experiences a pullback, it can be quite unnerving. However, stock market pullbacks, declines and drawdowns are a natural part of the investing lifecycle and are quite common. Small declines can always feel like the beginnings of a larger downslide in the markets, but over time many end up being small bumps on the way to another all time high.
To begin, the chart below shows the range of drawdown the S&P 500 experiences and the number of times it has happened between 1950 and 9/18/20. It is important to note that we experience about three drawdowns between 1% and 5% every year. Additionally, we experience a drawdown greater than 5% at least once per year but the more severe the drawdown, the longer the recovery.
Market declines in a year where the index finishes positive is not uncommon. The S&P 500 performance finishes positive 73% of the time, however, the average peak to trough decline within a year is 13%. This can be seen in the graph below from JPMorgan Guide to the Markets1 that shows the calendar year returns and the intra year peak-to-trough declines. Although the index may finish positive, it isn’t uncommon to experience intra-year declines of 10% or more.
Furthermore, 2020 has been a year of uncertainty and can be seen in the daily price moves of the S&P 500. Year-to-date, the market has had 37 days where the S&P 500 was down more than 1%, which is the most since 2011 and can be seen in the chart below. The heightened number of declines greater than 1% can create a sense of uncertainty that can lead to pull backs in the market.
Lastly, as history suggests, pullbacks in the market are relatively common and often provide investors a chance to invest at better prices that could enhance return. At Gradient, we actively examine market pullbacks to take advantage of opportunities as they present themselves. For example, in late July, the investment committee made the decision to move a portion of the tilt series allocation to cash, which realized some profits and provided some dry powder should we get a better opportunity.
While we believe in an actively managed strategy that adjusts a portion of capital based on market opportunity, we do not believe that “all in or all out” market timing strategies. The market is simply too difficult to time properly to make these kinds of adjustments and are also a deviation away from the investor’s intended objectives and risk tolerance.