Drawdowns and bear markets in the S&P 500 are a normal part of investing. A drawdown refers to a decline in the value of an investment from its peak value, while a bear market is a period where the overall stock market experiences a significant decline.
In this article, we will explore and analyze the characteristics of drawdown and how these findings can help investors to navigate stock market volatility, minimizing the impact of these market downturns on their portfolio and protect their investments during market turmoil. That is why it is important to understand the nature of drawdowns and being prepared in terms of having a plan in place.
There are several strategies that investors can use to minimize their impact.
- One strategy is a buy and hold approach, where investors continue to hold onto their investments during a market downturn, with the belief that the market will eventually recover. This strategy requires a long-term investment horizon and a high level of risk tolerance as shown below.
- Tactical investment strategies are also a popular way of navigating drawdowns. These strategies involve adjusting the portfolio allocation in response to market conditions. For example, investors may choose to reduce their exposure to equities or to use stop-loss orders to limit losses during a market downturn.
- Diversifying your portfolio across different asset classes such as stocks, bonds and commodities is also a proven way to mitigate the risk of drawdowns. This strategy aims to reduce the overall portfolio risk by investing in different types of assets which can have different returns characteristics, thus, reducing the overall portfolio volatility.
A History of Drawdowns – A Statistical Analysis from 1928 until 2023
Although most investors easily can recall most of the major stock market crisis, stronger drawdowns appear quite regularly. To illustrate the frequency and impact we have created a comprehensive analysis detailing the classification of stock market drawdowns (measured by the S&P 500) based on the magnitude of peak to valley loss.
The chart categorizes these drawdowns into four levels of severity: Bear Markets, Stronger Corrections, Corrections, and Pullbacks. Bear Markets, represented by a drawdown of more than 20%, are considered the most severe market downturns. Stronger Corrections, with losses ranging between -10% and -20%, are the next level of severity. Drawdowns classified as Corrections, with losses between -5% and -10%, and Pullbacks, with losses between -3% and -5%, are considered less severe in comparison.
In addition to providing a clear classification of market drawdowns, this analysis also includes important data such as the average loss and average time to until the final low was reached for each category, represented by dotted lines on the chart from 1928 to 2023.
S&P 500: A History of Drawdowns
Maximum Drawdowns from Closing Highs versus Days-Until-Low-Reached (dashed lines = average)
Bear Market Analysis (drawdowns less than -20%):
The S&P 500 has experienced 15 bear market downturns with losses greater than 20% from its peak since 1928. A bear market is a period of declining stock prices and is typically characterized by widespread pessimism and negative investor sentiment.
From 1928 to the present, the average bear market loss for the S&P 500 was 33.4% and it took an average of 406 days to reach the lowest point. The most severe bear market in terms of loss and length was during the Great Depression, which resulted in a loss of 82% and took 996 days from peak to trough. The Financial Crisis of 2008, with a loss of 48%, was the second largest drawdown, but it took only 407 days to reach its low in March 2009. The dot.com bear market of 2000-2002 was the second longest, taking 685 days to bottom, followed by the bear market in 1973 and the end of 1980, both with 629 days each.
The fastest bear market on record was during the Corona Crisis, as the S&P 500 dropped from peak to low in only 32 days, followed by the Black Monday in 1987 which took only 54 days. Between 1928 and 2023, the S&P 500 has experienced bear market declines lasting in total 8520 days, or 25% of the full observation time.
Stronger Corrections (losses ranging between -10% and -20%):
Since 1928, the S&P 500 has experienced 18 stronger corrections with downturns ranging between -10% and -20%. These corrections have an average loss of 13.4% and take an average of 129 days to reach the lowest point. The longest correction in this category occurred between August 1959 and October 1960, with a loss of 13% and a duration of days until low of 448 days. The second longest correction in this category was in July 1983, with a loss of 12.5% and a duration of 363 days until low. On the other hand, the fastest correction in this category happened in September 1955, with a duration of only 15 days until the low was reached and 34 days until reaching a new all-time high. The second fastest correction in this category was in March 2000, with a duration of 18 days until the low was reached and 89 days until reaching a new all-time high. Between 1928 and 2023, the S&P 500 has undergone a total of 18 declines (ranging from -10% to -20%), lasting 3286 days, or approximately 9.4% of the full observation time.
Corrections (losses ranging between -5% and -10%):
Between 1928 and 2023, the S&P 500 experienced 51 drawdowns from closing highs classified as corrections. These corrections had an average loss of -7% and an average duration of 33 days until reaching the lowest point. However, it is important to note that the mean duration of 33 days is skewed by an outlier correction in September 1967, which took 161 days to reach its low. Therefore, most corrections in fact took less than 33 days to reach the lowest point, with a median duration of 26 days. In total, the market declined for a total of 1701 days within this category, representing 4.9% of the time between 1928 and 2023.
Pullbacks (losses ranging between -3% and -5%):
Between 1928 and 2023, the S&P 500 experienced 74 drawdowns from closing highs classified as pullbacks. These corrections had an average loss of -4% and an average duration of 19 days until reaching the lowest point. The fastest pullback from an all-time high, at 3%, occurred in November 2021 and lasted only one day. On the other hand, the longest pullback in terms of days until low was the 4.9% pullback which started in August 2016 and lasted 80 days. Another interesting fact is that most pullbacks took place only within a few days, showing that the average duration of 19 days until a low was reached is skewed by a few outliers. In total, the market declined for a total of 1417 days within this category, representing 4% of the time between 1928 and 2023.
Key takeaways for risk management and trading strategies: finetune your calibration & time horizon
Navigating volatile times in the stock market can be a challenging endeavor, especially for non-professional traders. Additionally, the temptation to react to every small pullback and capitalize on sudden intraday price increases and to pyramid on profitable trends can be hard to resist, but it can also be difficult to achieve profitability in the long run. This is because high levels of leverage are often required to offset transaction costs, and the ability to execute trades quickly is also a critical factor.
As shown above, the duration of pullbacks until a low is reached may be to short-lived for non-professional investors to react on time and thus, be profitable. This is probably one of the most important reasons why many investors fail to succeed in the market. Therefore, it’s essential to calibrate your indicators, risk management, and trading strategies to achieve an ideal mix between leverage, portfolio impact inclusive transaction costs and time for execution.
For example, the research, indicators, and tools provided by WallStreetCourier are specifically designed to help investors avoiding significant losses, starting from corrections up to bear markets (which still account for 39% of time according to our analysis shown above). Instead of reacting to every market tick, we focus on (1) trades that have the biggest impact in terms of return on investment, including transaction costs and (2) the valuable time of our subscribers in placing orders and monitoring the market.
By following a well-rounded and well-calibrated strategy, investors can minimize the impact of market downturns on their portfolio and protect their investments during market turmoil, while maximizing returns in the long run.
Why avoiding larger drawdowns matters?
It is crucial to not only focus on maximizing returns in the long run, but also on minimizing losses. To maximize returns in the long-term, it is important to have a solid investment strategy in place that considers your risk tolerance and long-term goals. However, it is equally important to be mindful of potential losses and to have a plan in place to mitigate them.
For example, if an investor loses 50% of his portfolio value, he will need to gain 100% to recover that loss. This highlights the importance of not only aiming for gains, but also avoiding significant losses. It is much more difficult to recover from a large loss than it is to continue to build upon small gains. Therefore, risk management and loss prevention should be a key component of any investment strategy. That’s why we make it a priority to incorporate these principles in all aspects of our research and analysis.
Maximize Return Opportunities But Focus on Avoiding Losses First
A % loss followed by the same % gain will NOT get you back to the same point.
The S&P 500, as a measure of the overall stock market performance, has undergone a variety of drawdowns and bear markets throughout its history. These market downturns can vary in terms of their severity, duration, and impact on investments. Despite the regularity of these market downturns, investors can still navigate them effectively by having a well-defined strategy in place. By understanding the historical patterns of the stock market, investors can calibrate their investment strategy accordingly and make informed decisions to mitigate potential losses, while maximizing returns.
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