On Monday, the Dow Jones Industrial Average was down 1,175 points, the largest single-day point loss in history.
On Monday, the Dow Jones Industrial Average was down 4.6 percent, the 108th worst percentage drop in history.
Both of the above statements are true.
One elicits a great deal of fear and can be somewhat misleading to the average person.
The other, while still a bit unnerving, is not that unusual in the grand scheme of market history.
I’ll give you one guess as to which version of the statement most media outlets ran with last night …
Four percent drops in the stock market, while somewhat rare, aren’t that unusual. What’s unusual are extended market rallies with little to no drawdowns and non-existent volatility. That was the experience in the stock market throughout 2017 and it was an aberration, not the norm. Don’t let anyone ever fool you otherwise.
Almost every 5-10 percent correction “feels” like one of the big ones when it first gets started. But in reality, moves like these are a normal and regular part of investing in the stock market. Don’t just take my word for it – let’s take a look at the data.
Intra-year Declines Are Normal, Even in the Best Years
J.P. Morgan regularly updates the chart below as a recurring part of their Guide to the Markets piece. The dark grey bars represent the price return of the S&P 500 in each calendar year, while the red dots and the numbers below them show the largest intra-year drop in the market during those same years.
Despite the grey bars being positive in 29 out of the 38 years provided (and that’s before taking into account reinvested dividends), you can clearly see that almost every one of those positive years experienced drawdowns of at least five percent. In many positive years, the drawdowns were at least 10 percent, and in some greater than 20 percent. Even the best years have some very bad days, weeks, and even months.
Two Percent Down Days Aren’t That Rare
While we haven’t seen this kind of volatility creep up for a couple of years, last Friday and yesterday were actually the seventeenth and eighteenth – respectively – “down two percent or more” days for the S&P 500 since the beginning of 2013, as Michael Batnick points out over at his blog.
Imagine if you had gone to cash after one of those “down two percent or more” days in early 2013. Or 2014. Or 2015. Or 2016. You get the idea …
Ben Carlson wrote a column for Bloomberg View in which he took a deep dive into daily moves in the S&P 500 since 1950. What he found was that movements greater than two percent to the downside actually occurred in over two percent of all trading days. Taking it a step further, days where the market was down one percent or more accounted for nearly ten percent of all trading days.
Yesterday in the Context of the Current Bull Market
Not only was yesterday not even close to the worst day ever for the stock market, it wasn’t even one of the five worst days for the S&P 500 in the current bull market. In fact, it barely made the top ten, coming in at number nine.
Five of the worst ten days in the current bull market took place in 2011. At the end of 2011, the Dow was around twelve thousand. It has doubled since then.
Naturally, after days like these, you will happen upon pundits and so-called experts pontificating as to “why” the selloff was triggered. Some of the reasons you will see cited this time include:
- Increases in interest rates
- Concerns about rising wages and inflation
- High valuations for stocks leaving little margin for error
- A brand-new Fed chair
- Political tensions
- Systematic selling by algorithmic trading programs
Ultimately, these exercises in explaining market movements are fruitless and benefit tremendously from 20/20 hindsight. In reality, financial markets are complex, adaptive systems that involve millions of participants with varying goals, time-horizons, opinions and objectives.
To paraphrase Jason Zweig of The Wall Street Journal, the stock market didn’t get tested yesterday – investors did. Here are a few tips on how to “pass” tests like yesterday:
- Understand your true time-horizon: Equity investments should be made with time horizons measured in decades rather than days. Maintaining the long-view can help block the noise out.
- Diversify beyond the stock market: While stocks suffered quite a bit yesterday, bonds for the most part generated positive returns and helped cushion the downside. Most investors should have a healthy balance of stocks, bonds and other diversifiers.
- Make sure you can sleep well at night: If days like yesterday might cause you to engage in poor behavior or burden you with undue stress, it might make sense to reexamine your asset allocation. After all, a good portfolio you can stick with is vastly superior to a great portfolio you can’t stick with.
In closing, I’ll leave you with a quote from legendary investor Peter Lynch:
“The real key to making money in stocks is not to get scared out of them.”