TradingGods.net

Recent Stock Market Declines Impacting Investor Sentiment

The stock market has been tumbling lately, which means that dramatic media headlines are roiling investor sentiment far and wide.

 

By James Picerno

 

As a result, recency bias threatens to overwhelm otherwise rational minds. To be fair, October looks pretty grim and the latest market rout could roll on… or not. But before you let your emotional demons take over all your decisions, take a moment to consider the historical perspective, which tends to be overlooked in times like these.

Consider, for example, how the world’s most popular benchmark for US stocks — the S&P 500(NYSEARCA:SPY) – stacks up via several measures that attempt to put the latest slide into broader context. Let’s start with drawdown. The current peak-to-trough decline is 9.4%, based on data through yesterday’s close (Oct. 24). That may sound like a hefty haircut, particularly if you were counting your profits when the market reached an all-time peak last month. But as the past 60-plus years remind, a ~9% drawdown for the S&P is about as unusual as sand in the Sahara.

As the boxplot below shows, the current drawdown is extraordinarily ordinary, as indicated by the red box that’s more or less in the middle of the interquartile range (yellow box) of drawdown results since 1955. In other words, the peak-to-trough decline through yesterday is “normal”.

Retirement Day Trader - eBook

Sign up for our Newsletter & get the FREE eBook
Retirement Day Trader:
How to Sell Weekly Options for Steady Income

  • This field is for validation purposes and should be left unchanged.

Let’s turn to returns. If you’ve been reading the breathless reporting by the usual suspects, the latest market slide harbors great drama, and by the standards of the last several weeks that’s true. But filtering the data through a one-year-return lens over the course of decades takes some of excitement out of the analysis. The S&P is up 3.4% over the past year via a 252-trading-day window (before factoring in distributions, which is the standard throughout this post). Yes, that’s well below the 9.7% median return since 1955, but the S&P’s rolling one-year performance is a volatile beast and so it’s not unusual for this definition of historical return measure to bounce around by more than a trivial degree. In any case,  the current one-year return is far from unusual, as indicated by the latest data point that’s still comfortably inside the interquartile range of historical results in the boxplot below.

The annualized 10-year return is a superior measure of how performance stacks up in history and on this score the current gain still ranks as impressive. The trailing 10.8% return over the past decade is not only well above the median ten-year gain since the mid-1960s, it’s also a performance that’s slightly above the interquartile range of results. In short, if you bought an S&P 500 index fund a decade ago, you’re still sitting on a gain that’s uncommonly elevated by the standards of rolling 10-year results for the past half century. At the same, a strong 10-year trailing return implies that something less impressive could be coming.

That’s all well and good, but in the wake of a sharp correction this month the burning question is what happens next? Alas, there’s only speculation on that front. But there are some obvious factors to consider for thinking about what may be waiting in the wings. For starters, the US economy is still trending positive to a solid degree, which is to say that recession risk for the moment remains low.Tomorrow’s preliminary estimate of third-quarter GDP is expected to reaffirm that the US macro trend remains healthy.

True, there’s rising suspicion that growth is slowing and that various risk factors, including an ongoing trade war between the US and China, will create trouble in 2019. Perhaps, but for now it’s best to let the incoming data guide your decisions on strategic portfolio matters. There’s a risk that the future could deliver downside surprises, but the opposite is possible as well.

This much is clear: the inverse relationship between stock prices and expected return is intact. As such, the longer the correction rolls on, the better the ex ante opportunities. You won’t find that truism in a newspaper headline, but it’s no less valuable as a premise for managing investment portfolios.