Don’t Lose Sight of How Strong Rebounds Have Historically Been After Corrections
- The maximum peak-to-trough correction in the S&P 500 Index thus far has been 13% (1/3/22-3/8/22).
- Corrections of that size (10-15%) have historically been followed by 21.9% average gains off the lows in the subsequent year, with gains 92% of the time.
- We of course don’t know if this correction goes deeper as the geopolitical and inflation threats are extremely difficult to predict, but also keep in mind the average annual maximum drawdown historically has been 14%. The S&P 500 is down 11% from its January high after Wednesday’s rally.
- The still-favorable economic and corporate fundamentals in the U.S., our expectation that inflation is nearing its peak, and analysis such as this, keep us comfortable with our overweight equities position even amid high volatility.
The preceding chart shows all the 10% corrections since 1980, bringing back some interesting memories for long-time market watchers. What stands out is the future returns are extremely strong: A year later, up 25% on average and higher 90% of the time. This analysis reminds us that panicking in the face of weakness probably isn’t the best way to reach longer-term investment goals. Take note, this resets once the S&P 500 has a 10% rally; that is why you likely don’t see some of the 50% haircuts after the tech bubble and Financial Crisis.
And although pullbacks don't feel fun, they are quite normal and something that should be expected and part of your financial plan. The average year sees nearly three separate 5% corrections, putting in perspective just how rare last year was with only one and why greater volatility this year would be quite normal.
Taking it out to 10% corrections, the S&P 500 has about one per year, but again, we haven’t seen one of those since March 2020. There was a 9.6% correction in September 2020, but that’s as close as we got. With the S&P 500 currently down 9.2% from the peak earlier this year, we could be looking at our first correction quite soon. But again, is this really surprising? Investors who came into 2022 with a plan likely anticipated the chances of a double-digit correction at some point in the year, so this shouldn’t be a major shock.
It is often said that volatility is a feature of the markets, not a bug. This is why we expect better long-term returns when we invest in the stock market compared to other investments like bonds or regular savings accounts. As individuals, we are not all the same with our comfort of risk or what we hope to accomplish for our financial goals. What's important is that you have a plan that is tailored to you and fits your needs and goals.
This isn't the first time the markets have been volatile and it won't be the last. When we take the time to put things into perspective, like volatility, we can often see how they are normal and something that should be expected. Often times, these events can open the door to opportunities to improve on your long-term success by doing simple things like rebalancing your portfolio.
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