Preparing Clients for Market Declines
- The current bull market run has been remarkably tranquil, but it’s important to condition clients to the fact that a correction could come at any time.
- Positioning portfolios to endure potential setbacks has historically been far more effective than making abrupt moves following some kind of market action.
- Our research shows that equities have tended to gain a majority of the time in most market cycles, and providing this perspective (along with setting aside cash for immediate short-term expenses) may be helpful in keeping clients invested even during tough times.
One of the most noteworthy elements of the current bull market has been its remarkable tranquility. Currently in its ninth year, this advance has been marked by extremely low volatility with very few selloffs. It’s a historic rally: The Standard & Poor’s 500 has posted a positive total return in each of the past 15 months — a feat that’s occurred just once before, in 1960, according to S&P Dow Jones Indices.
Still, history tells us that even the most vibrant rallies eventually give way to selling pressure, either temporary corrections or more damaging bear markets. It is difficult to predict when a correction will set in — or when a correction might deepen into a full-fledged bear. The market reminded investors about volatility on Feb. 2 when the Dow Jones Industrial Average fell more than 650 points. That daily decline resulted in a 4.1% loss during the week — the largest since January 2016, which had followed a global market decline sparked by concerns about Chinese stocks.
Nevertheless, it’s helpful to understand the nature of past downturns to assist in your conversations with clients. To shed greater light on this subject, our researchers analyzed the length and severity of past market drops. Though the precise causes often vary from one selloff to another, we found that there are two fundamental types of declines: major pullbacks, which often correspond with recessions, and shorter lived downturns that occur in the course of
longer lasting rallies.
In the postwar period, the S&P 500 has dropped 15% or more on 16 occasions. Half of those downturns were relatively mild, lasting less than eight months. Nearly one-third of the time, the index was at a new high within 10 months of the previous peak.
As for major pullbacks, the median duration was 17 months, with a drop of more than 30%. Again, these declines are typically associated with recessions.
Thus, gauging the potential depth of a market decline involves trying to determine the stage of the economic cycle. Currently, our research suggests the U.S. economy is not exhibiting any of the obvious excesses or imbalances that historically have foreshadowed economic contractions.
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