Long-term investors shouldn’t worry too much about stocks being within 10% of their highs

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Traders work on the floor of the New York Stock Exchange (NYSE) in New York, United States, January 21, 2022.

Brendan McDermid | Reuters

Should we be worried?

At one point on Monday, the S&P 500 was down 10% from its recent highs.

However, panicking investors should keep long-term trends in mind.

What is unusual is not that we had a 10% correction; what is unusual is the amount of time that elapsed between corrections.

In February-March 2020, the S&P 500 fell about 33% before recovering.

Prior to that, the last 10% decline occurred at the end of 2018, when the Fed talked about aggressively raising rates. This period – from late September to just before Christmas – resulted in a 19% decline for the S&P 500.

This represents two corrections of more than 10% in the past three years and two months. This equates to a correction every 19 months.

While that sounds like a lot, it’s below the historical norm.

Corrections of 5% to 10% are normal

In a 2019 report, Guggenheim noted that corrections of 5-10% in the S&P occur regularly.

Since 1946, they noted that there had been 84 declines of 5% to 10%, which equates to more than one per year.

Fortunately, the market usually rebounds quickly from these modest declines. The average time it takes to recover from these losses is one month.

Deeper declines have occurred, but they occur less frequently.

Decline in the S&P 500 since 1946

Decline # of refusal Average recovery time in months
5%-10% 84 1
10%-20% 29 4
20%-40% 9 14
40%+ 3 58

Declines of 10% to 20% have occurred 29 times (about once every 2.5 years since 1946), 20% to 40% nine times (about once every 8.5 years), and 40% or more three times (every 25 years).

Two points to remember: first, most declines greater than 20% have been associated with recessions (there have been 12 since 1946).

Second, for long-term investors, it tells you that even relatively rare but severe pullbacks of 20% to 40% don’t last very long — just 14 months.

The S&P 500 is up 3 out of 4 years

Another way to slice the data is this: when dividends are taken into account, the S&P has risen 72% of the time year-over-year since 1926.

This means that about one in four years the market is down. It can (and does) stitch chains of years down.

But this is not the norm. In fact, the opposite is true. More than half the time (57%), the S&P shows gains of 10% or more.

S&P500

S&P500 % advance each year
20% + advance 36%
10-20% advance 21%
0-10% advance 15%
0-10% decline 15%
10%+ decline 13%

The Fed: Is this a secular change in stocks?

Yet, could a deeper, longer-term correction occur?

Even bulls admit that the last 12 years have been exceptionally rich for market investors.

Since 2009, the S&P 500 has averaged gains of around 15% per year, well above historical returns of around 10% per year.

Many traders attribute this five percentage point annual outperformance largely to the Fed, which not only kept interest rates extraordinarily low (making cheap money abundantly available to investors) but also pumped huge amounts of money in the economy by expanding its balance sheet. , which now stands at around $9 trillion.

If that’s the case – and all or much of that excess gain is due to the Fed – then it’s reasonable to expect the Fed to withdraw liquidity and raise rates could explain a future run of returns. lower than normal (lower than 10%). .

This is Vanguard’s view. In its 2022 economic and market outlook, the mutual fund and ETF giant noted that “the removal of political support poses a new challenge for policymakers and a new risk for financial markets.”

They described their long-term outlook for equities as “watched”, noting that “high valuations and weaker economic growth rates mean we expect lower returns over the next decade”.

How much lower? They expect returns from a 60/40 stock/bond portfolio to be about half of what investors have realized over the past decade (from 9% to about 4%).

Yet Vanguard does not expect negative returns; they simply expect lower returns.

What does it mean for stocks to be 10% off their highs?

You heard it all day Monday: “The S&P 500 is at 10% off its highs!

That’s true, but how relevant is that to the average investor?

How many people do you know who invested all their money at the market high and took it all out at the market low on Monday? Yes, many people panic at the bottom, but very few have invested all their money at the top of the market.

Most people engage in some form of dollar cost averaging where they invest money over many years.

This means that when stocks fall, they almost certainly fall by a higher price than you paid for them.

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