Market Drawdowns and Forward Returns
As we approach the mid-point of the year, uncertainty abounds. An ongoing supply chain crunch, a hot housing market, high inflation, a Fed rate hiking cycle, and war in Ukraine are contributing to recessionary fears, economic pressure, rising interest rates, and a volatile stock market. The only certainty is uncertainty as the global economy is chaotic, complex, and unpredictable.
There have been few places to hide. When looking at the major market indices, the aggregate bond index is in a 13% drawdown, large cap U.S. stocks are almost 15% off their highs (Russell 1000), small cap U.S. stocks (Russell 2000) are about 25% off, international developed stocks (MSCI EAFE) are 18% off, and emerging markets stocks (MSCI EM) are 27% off. If you are a growth investor, these drawdowns have been worse with large cap growth stocks down 22% and small cap growth stocks down 33%. (data through 5/6/2022)
Down markets such as these can instill anxiety, fear, and negative sentiment in investors. Looking at historical data in these moments can help investors to make decisions without letting their emotions take control. Below, we outline historical forward returns from periods in which U.S. stock market indices are 10% and 20% below their previous highs:
**The above sample period begins on 12/29/1978. Data from Ycharts and analysis by 1620 Investment Advisors.
The average and median forward returns from these drawdowns have been attractive and the chances of negative returns have been relatively low, especially when looking at small cap stocks (Russell 2000). The worst periods for forward returns occurred around the tech bubble of the early 2000s. Drawdowns that follow periods of heightened speculation and are driven by a large collapse in valuation multiples take much longer to recover from.
We use data exercises such as these to help guide our decision making in rough markets and to help our clients stay invested. Keeping a long-term, data driven mentality when investing in the stock market can help investors stay the course and highlight opportunities for rebalancing from bonds and cash into stocks.