Biggest Market Decline Ever?

That’s a title that gets attention and raises blood pressure, and it’s been the lead story for too many news outlets today. The stock market has experienced a lousy few days, without question. But the media talk is misleading, and the recent results warrant reframing. 

Many headlines cited today’s point drop in the Dow Jones Industrial Average, rather than its percentage drop. The Dow fell 1,175 points — a nasty outcome, and its largest point drop ever. But on a more meaningful percentage basis, the Dow was down 4.6% — a hardly comforting result, but only its 108th-largest percentage drop since 1900. That’s far-less-startling than “biggest market decline ever”. 

After today’s drop, the market is down 7% since mid-day Wednesday (1/31) — a terrible three-day run. But a glimpse at the last forty years of global stock market declines is instructive. As Figure 1 below shows, the largest decline within each year (represented by the orange dots) has been at least 12% in more than half of the years since 1979. And in 20 of the last 21 years, global stocks experienced intra-year declines of 7% or more, with 2017 being the sole exception. Interestingly, in most years with significant intra-year declines, the market still ended with a positive calendar-year return.

Figure 1 — Significant Market Declines Are Common

Figure 1 — Significant Market Declines Are Common

Despite their definitive claims to the contrary, neither journalists nor analysts know why markets rise or fall. Today, counterintuitively, most point to an accelerating economy as the problem. They argue that such momentum could cause central banks to raise interest rates and, in turn, economic growth to slow. Such a view is not new or shocking, so we don’t find it sufficient as an explanation for the market drop.

More likely, a few mildly surprising news items were the proverbial straws that broke the camel’s back. Or maybe the period since the 2016 presidential election was a bit too perfect — with the U.S. market up over 30% in just 15 months, without a single month of market loss. Or maybe, with an even wider view, the period since the bottom of the global financial crisis in March 2009 was finally a bit too much — with the U.S. market up nearly five-fold since, or nearly 20% per year for nine years! But, who really knows. We certainly don’t.

We are not unconcerned, as you know. We worry about demographic trends, productivity woes, corporate-profit margins, stock-market valuations, inflation, the Euro, global debt levels, Chinese growth prospects, artificial intelligence, and asteroid strikes.

But neither our level of concern nor our outlook has changed from two months ago, when the current stock market level was last encountered. The last time around, way back in the first week of December, the current level of stocks was seen with exuberance — global growth was accelerating, tax reductions were to drive corporate profits higher, and tax incentives were to accelerate corporate investment and economic growth. Today, just 40 trading days later, this same level of stocks is seen with panic — economic growth may accelerate, and interest rates may increase. However, at both points, we have maintained the same market outlook for the same market level: 10-year expectations for global stocks well below historical-averages, but still above 10-year expectations of global bonds, which sit near 5,000-year-low yields. 

So, for anyone with a long time horizon, exposure to stocks is warranted, despite the anxieties we have discussed for several years. And since your bonds are liquid and your allocation to stocks is at or below normal levels, you are prepared to take advantage of attractive market levels, should they arrive. At the moment, while we are far from excited about stocks in general, we are aggressively considering several individual stocks that have recently piqued our interest. Stay tuned.

In the meantime, we recommend looking far out on the horizon. It’s calmer out there. 

Short Note: Nowhere to Hide in 2018