U.S. equity investors have experienced frequent bouts of volatility over the last several years, giving life to the old investment adage ‘good markets aren’t volatile, volatile markets aren’t good’. While this may hold true at certain points in time, it is important to understand what to expect in terms of ‘normal’ market volatility that investors will experience in any given year.
In almost every calendar year the stock market experiences a 5-10% intra-year drawdown. They can & should be considered ‘normal’. As illustrated in the first table below, 90% of all years since 1980 have experienced at least a 5-10% intra-year drawdown. Despite these intra-year declines, nearly 80% of those years continued to finish the calendar year with positive returns.
Source: Bloomberg
Furthermore, the next chart below shows calendar year returns for the U.S. stock market since 1980, as well as the largest intra-year drawdowns that occurred in each year. During this period (1980-2020), the average intra-year drawdown was 13%. Despite having to withstand this ‘normal’ volatility, investors were rewarded with an average annual return of 13.3% & 79% of years finishing positive.
Source: Bloomberg
In spite of 5-10% intra-year drawdowns being ‘normal’, every bear market begins with a 5-10% decline. Therefore, it is important to be able to distinguish between ‘normal’ volatility and the type of volatility that is likely to escalate into a stock market crash and/or severe bear market. At VGA, we follow an objective ‘weight-of-the-evidence’ process, with proprietary indicators & models that are designed to differentiate between ‘normal’ market volatility & noise that occurs in any given year from conditions that may lead to something more damaging for investors.
To help illustrate this point, we have included two contrasting time periods from recent history. The first period is from the 2Q’2019, which saw the escalation of the U.S. / China Trade War. The second period is from the 1Q’2020, which coincided with the upsurge of the Coronavirus Pandemic. As you can see, the U.S. / China Trade War (left) saw a ‘normal’ market decline of 8% versus the Coronavirus Pandemic (right) total decline of 34%. VGA’s models remained bullish throughout the first scenario, correctly deciphering the volatility as ‘normal’. Alternatively, the second scenario saw VGA’s models turn decisively bearish & correctly signaled the start of a deeper decline that warranted increased protection & hedging.
Source: Bloomberg
Knowing what to expect as well as correctly identifying environments that exhibit ‘normal’ volatility is paramount to continued investment success. The VGA Investment Team is prepared with our objective ‘weight-of-the-evidence’ indicators & models to help our clients navigate through turbulent times & continue to grow and preserve their wealth.
