How Markets Respond to Drawdowns

How Markets Respond to Drawdowns

October 03, 2022
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“Everything in boxing is backwards.” -Eddie Dupris, “Million Dollar Baby”

When markets are down, the natural bias is to sell. But looking at history, the more the S&P 500 is down, the better it does in the next year, on average. Like boxing for Eddie Dupris, everything in investing is backwards.

Below we look at how the S&P 500 has performed based on how far down we are from the highest point over the prior year. That’s the “drawdown.” These are averages and there’s a big range of individual outcomes around each one. But the averages do tell a story.

View enlarged chart.

  • There’s not a lot of clarity over the next three or even over the next six months, on average, for large drawdowns.
  • Once you get past a 10% drawdown, the subsequent average one-year return improves as the drawdown gets worse.
  • When you’re up to 15% below the prior one-year high, which covers almost 80% of all days, returns one year out are typically below average by about 1%.
  • When you’re down at least 15%, the subsequent one-year return is above average.
  • Drawdowns in bear market territory (larger than 20%) make up just under 7% of the data points and have a historical average return of 17.6% over the next year.
  • The average one-year return when in the drawdown range we’re experiencing right now (-20% to -25%) is 11.5%, meaningfully above average but not an outsized return.

Current conditions matter, but history is always a good starting point for evaluating where things may go moving forward. Looking at similar markets to where we are now, with likely an equally gloomy outlook in real time, the takeaway favors buying over selling, all else equal, and if nothing else standing pat.

 

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