October 2018 was a volatile month for markets. When there was similar market volatility in February 2018, we reached out to clients to provide perspective on what we viewed as a healthy pause in an otherwise lengthy bull market. The decline in February caused mild concern amongst investors, but the speed and precipitous nature of the more recent decline has caused a great number of investors to feel unsettled.
Prior to this year, we discussed how common it is to experience drawdowns of varying depth, as shown in the following table:
While we can share plentiful data on the commonality of drawdowns, it typically provides little comfort as real-time losses are occurring. Nevertheless, we believe that more context is helpful in these situations and below we add further thoughts.
Although it may not seem like it from the strong performance in recent years, US equities are not in the habit of hitting new highs every day. In fact, US equities are in the midst of a 10% drawdown (meaning more than 10% lower than recent peak) 30% of the time. The market volatility of February/October 2018 exacerbates this effect by being very quick, but it is not atypical.
When looking at 10% declines historically, 66% of them have not come during periods that precede or coincide with a recession. This is not a call on a recession, just context for the often-quoted line from Paul Samuelson that “the stock market has forecast nine of the last five recessions”.
Some of the negative headlines from earlier this year remain, offsetting some of the robust economic and earnings growth domestically and overseas. New headlines (though not new happenings) include destabilizing geopolitics in Iran, Saudi Arabia, Italy, Russia, Brazil and elsewhere.
We do not want to marginalize any of the above, but also caution on making investment decisions based on short-term, macro-economic factors. This is a sentiment found in most of our quarterly letters, notably in our “Choose Your Own Misadventure” posting from late 2016.* For each one of these new headlines, others have fallen to the back pages or out of the conversation entirely, including NAFTA, North Korea, ISIS, South China Sea, and broken market volatility trades. In short, there is always headline risk, in part, because every day requires a headline.
We are not saying the market is without risk. Rising interest rates and debt burdens are a long-term concern for companies and governments alike. We continue to closely monitor credit spreads for signs of dislocations, but they have not moved materially during times of equity market stress this year.
We have noted over the past few years our tempered expectations for future returns and the reappearance of volatility. A sell-off like the one we are seeing now is par for the course. From a portfolio standpoint we are not recommending any material changes or knee-jerk reactions. That said, we will continue to monitor the evolving market dynamics for potential opportunities.
*To view our quarterly commentaries, click here.