Sometimes when things are too calm for too long, you start to get suspicious. Parents to younger children know this all too well.
If you haven’t seen – or more importantly, heard – your child in some time, warning signals instinctively begin to go off in your head. The kid is up to something.
The stock market sometimes feels like that, too. It’s been calm for quite some time.
So I’d like to offer a periodic reminder that the stock market at times does bad things and probably will again in the not-too-distant future. When – no one knows. That’s anyone’s guess. But you should be ready for it to happen.
I’ll offer some advice regarding how to prepare for such an event a little later, but first, let’s talk about how long the market has been suspiciously quiet.
There are two stats that best tell the story.
The first is the average intra-year drawdown. The U.S. stock market ends in positive territory about 75% of all years. But along the way, even in the years that end in positive territory, there are typically flash periods when the market falls for some time. In the industry, we call those “drawdowns.”
If we look back to 1980, the average intra-year drawdown for the U.S. stock market is 14%. So at some point in any given year, we should expect the market to be down somewhere in the neighborhood of 14%, even if it ultimately finishes the year with a gain.
Thus far in 2024, the largest drawdown we’ve seen is 8.5%, which occurred in late July and early August. But even before the calendar turned to 2024, we had already been experiencing dampened volatility in the market. In 2023, the largest drawdown was 10%, again less than the historical average of 14%.
The second stat tells a similar story. Look at the days where the market ends either up 2% or down 2% or more. Anything between those two points is fairly normal. Anything outside of them means something significant has seriously excited investors or spooked them.
Until late July, we had a streak of 104 days that were in that 2% up, 2% down range.
But honestly, most investors aren’t terribly concerned about days the market ends up 2% or more. It’s the 2% down days that are really unnerving. And that’s where we had an unusual streak going. It had been 356 days since the U.S. stock market experienced a 2% or more down day before the streak ended on July 24.
That’s oddly calm for the stock market.
That being said, as every parent also knows, sometimes you suspect your child is up to no good but find them peacefully reading or playing in their room. The same could hold true for the stock market. Just because it’s been calm, doesn’t mean it has to turn volatile. Perhaps we’re in a happy lull that will play out a while longer.
You should prepare for worse, though. Not because it is imminent but because it’s always good to be prepared. If you can’t stand the thought of seeing your portfolio value fall by 15-25%, now is the time to do something about it, while the stock market is still near its all-time high. For most investors, however, the best course of action is to do nothing. Sit back and watch the show.
The worst thing an investor can do is to sell out of fear. So start preparing yourself for lower investment values now; that way you aren’t tempted to do something rash in the midst of an inevitable drawdown.
Just a periodic reminder: The stock market does go down – and on occasion, those drops can be quite severe. That’s nothing to fear. It’s the price we pay for healthy long-term returns.
We haven’t seen such an environment for at least two years. But we should expect it, sooner or later.
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