Historical Perspective on Stock Market Declines (February 2022 Newsletter Excerpt)

This past month we saw escalated volatility in the capital markets. It was the worst performing month since March 2020 when the pandemic was driving panic. The context and reasons for this more mild rout in January are completely different than we saw in 2020.

In the past month, we received mixed news for the economy. Gross domestic product grew 6.9% in 2021 – the strongest economic growth since 1984, and far higher than the consensus expectation of only 5.5%. In January, the unemployment rate fell to 3.9% – not quite to the February 2020 low of 3.5%, but nothing to complain about. On the other hand, inflation was at the highest level since 1982, raising expectations that the Federal Reserve will increase interest rates.

There was also good news and bad news in the general headlines. It’s too far early to tell, but there is hope that the pandemic may shift to being endemic. It was never realistic that the virus would completely go away, but hopefully mutate into a more benign form – like the 1918 Flu. In global news, there was some saber rattling with Russia. Like much of our relationship with Russia, this situation is opaque. The uncertainty is bound to occupy some part of investor mental real estate.

It’s anyone’s guess why the combination of these things led to investors to pull away from the stock market. Sometimes, the market pulls back simply because that’s what happens to anything overstretched. All bull markets must correct eventually, and often later than anyone expects.

It’s helpful to view this decline in terms of time. The market has pulled back to levels we haven’t seen since … three months ago! It feels a little different when we remind ourselves that last fall, we were celebrating these prices as records.

The Winter of Our Discontent

There is a great deal to glean from this:

1. Declines happen all the time. On average, every two weeks or so (11.42 calendar days is the average) you should expect to see the stock market drop at least 1.0–2.5%.
2. On average, you should expect to see the stock market go down 10–20% each and every year. It’s completely normal. Between January 3-27, 2022, the S&P 500 fell 9.5%.
3. Bear markets happen on average every 4.62 years. They are just as normal and cyclical as presidential elections. And just like elections, nobody likes them.
4. If your retirement is 30 years, you should expect to see more than six bear markets. Six times you will see the stock market take a breathtaking drop of more than 20%.

The good news:

1. Most declines (58.36%) are Routine Declines and never get worse than -2.5%.
2. 99.32% of declines never cross the 20% bear market mark and recover in less than six months on average.
3. Even declines in the 20–40% range require of you, on average, only two years of patience.
4. Even the nastiest of Extreme Bear Markets, on average, go away within what most people would describe as a “short investing time-frame” (6.59 years).

This past January’s drop counts as a “Moderate Decline” which normally happens every 2.83 months. We don’t know if this decline will continue onwards, but the data also tells us that only 21.50% of the time it escalates to a “Severe Decline”. If it doesn’t escalate, on average it takes 2.20 months before recovery.

The unusual aspect of this decline is that it feels so unusual. We haven’t seen volatility like this in two years and it may feel disproportionately significant.