by: Richard A. Anderson
Things can change quickly. If I was writing this post one month ago, it would be a completely different topic with a much different tone.
Following four straight months of positive performance to start the year, the S&P 500 posted a -6.35% return in May. This was the third time in eight months the S&P 500 had a monthly loss of more than 6%. Fears of a full-blown trade war were reemerging as trade negotiations with China soured and it looked like fresh tariffs would be imposed against Mexico. The trade wars would put downward pressure on an already slowing global economy, putting even more pressure on central banks to ease monetary policy.
To make matters even worse, the S&P 500 was at the same level as mid-January 2018. Said another way, the S&P 500 had essentially been flat for 18 months.
As you can see from the chart above, the S&P 500 ended May at the same level as mid-January 2018 but had many ups and downs over that time period.
Had I been writing this post one month ago, I would be urging you not to fear stock drawdowns. Short time periods of losses are common and are the reason we as investors are rewarded. 18 months may sound like a long time, but when we’re talking about a typical investor’s time frame it’s a drop in the bucket.
We know the average intra-year decline for U.S. stocks dating back to 1979 is 14%. We know there is an average of 3 drawdowns of 5% or more in each calendar year. We know on average a drawdown greater than 10% occurs about once a year. But just because we know these things to be true doesn’t make it any easier to live through them. It’s always easier to stick to a plan during a hypothetical drawdown than it is when that drawdown becomes a reality.
Fast forward one month and the S&P 500 posted its best June since 1955 on its way to reaching a new all-time high. Stocks rallied due to a trade deal with Mexico, expectations the Fed would cut interest rates in the near future, and positive outlook for trade negotiations with China.
As I am writing this now, the tides have changed. Rather than urging you not to fear drawdowns I now urge you to not fear new all-time highs. As of the end of June, the S&P 500 has closed at a new all-time high 5 times this year. New all-time highs can result in a range of emotions. Some will feel elation, believing the markets will continue to ride higher. Some will feel fearful, believing the markets will fall. Some will feel regret for missing out on the ride. These emotions are normal, but it’s important not to let those emotions drive any investment decision.
The chart below shows the number of all-time highs by calendar year for the S&P 500. As you can see, all-time highs tend to cluster together and there can be long periods of all-time high “droughts.” For example, following the Great Depression stocks went about 25 years without eclipsing the 1929 highs.
To put this in a different light, dating back to 1928 there have been about 23,000 trading days. 1,215 of those 23,000 trading days have been all-time highs. About 5% of trading days are all-time highs. In contrast, that means we are in a drawdown almost 95% of the time. Over this same time period, the S&P 500 is up 542,633%. Stocks need to surpass previous highs and continue to hit new all-time highs in order to go up over the long-term.
There is always something that causes us to feel emotional, good or bad. That is why the topic and tone may change depending on the direction of the market, but the message stays the same: stay disciplined, focus on the long-term, and don’t worry about what’s out of your control.