Pullbacks & Bouncebacks
We can gain important perspective on market pullbacks by considering post-World War II declines in the S&P 500® Index. The majority of declines fall within the 5-10 percent range with an average recovery time of approximately one month, while declines between 10-20 percent have an average recovery period of approximately three months. Pullbacks within these ranges are not uncommon, occurring frequently during the normal market cycle. While they can be emotionally unnerving, they will not generally undermine a well-diversified portfolio and are not necessarily signals for panic. Even more severe pullbacks of 20-40 percent registered an average recovery period of only 14 months
1 Data as of 12.31.2018. Copyright 2019 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers, refer to www.ndr.com/vendorinfo.
In contrast, pullbacks of 40 percent or more, while occurring much less frequently, post an average recovery time of 57 months and can potentially compromise an investor’s financial plan. Pullbacks above 20 percent (including all pullbacks above 40 percent), which have registered the longest recovery periods, have been associated with economic recessions. When evaluating a market pullback, the probability of a recession is a key insight to consider when determining whether or not to reduce equity exposure.
While recessions are readily identifiable in hindsight, prospectively they can be difficult to spot. This makes access to reliable market analysis all the more important when determining the probability of a recession.
Where Are We Now?
(Guggenheim Investments provides its view of the current market environment - as of 3.2019)
U.S. economic growth was a strong 2.6 percent in the fourth quarter of 2018, though this represented a slowdown from the robust 3.4 percent pace recorded in the prior quarter. We expect growth to show a more meaningful slowing in the first quarter of 2019 to about 1.0 percent. This stems in part from tighter financial conditions, but reported growth is also likely to be weighed down by “residual seasonality” in the official statistics, along with the temporary impact of the government shutdown.
The good news is that sequential growth is likely to rebound in the second quarter as statistical and shutdown distortions are reversed. Nevertheless, growth is now on a downward trajectory in year-over-year terms. The combination of tighter Fed policy and fading fiscal stimulus will ensure that growth in 2019 is weaker than it was in 2018. Leading indicators confirm that the peak in growth is behind us, and our recession forecasting tools continue to point to a downturn starting by mid-2020. However, there is a chance that a Fed pause could delay a downturn until late 2020 or even early 2021, and we will be watching the data for evidence.
Meanwhile, the steady softening in global manufacturing purchasing managers’ indexes illustrates how global growth momentum has faded. Growth in Europe is sputtering, and the ongoing Brexit saga is still unresolved. The steady slide in Chinese growth has prompted authorities to announce a series of stimulus measures with more forthcoming, but policy lags will delay any positive impact.
Against this backdrop, the Fed has moved to the sidelines. A pause in the hiking cycle is likely for the first half of the year, but we do not believe the Fed is done tightening just yet. The labor market continues to strengthen, and we see further wage gains ahead. And while core inflation should remain soft in coming months, we expect it to rebound in the second half. Our baseline forecast now envisions one more hike later in the year. Further rate hikes may be required in 2020 should inflation expectations begin to rise meaningfully. Balance sheet runoff should conclude in the third quarter, with details likely to be announced at the March meeting. This will allay market concerns about balance sheet reduction being on “autopilot.”
Guggenheim’s Recession Dashboard and Recession Probability Model Point to the Next Recession in the First Half of 2020
The business cycle is one of the most important drivers of investment performance. It is therefore critical for investors to have a well-informed view on the business cycle so portfolio allocations can be adjusted accordingly. At this stage, with the current U.S. expansion showing signs of aging, our focus is on projecting the timing of the next downturn.
Guggenheim has developed several tools to guide this effort. The last several expansions have shown similar patterns leading up to a recession. We have created a Recession Dashboard of six indicators that have exhibited consistent cyclical behavior, and that can be tracked relatively well in real time. These six indicators include a measure of the unemployment gap, the stance of monetary policy, the shape of the yield curve, the Leading Economic Index, changes in aggregate weekly hours worked, and changes in consumer spending. In addition to our dashboard of recession indicators, we have also developed an integrated Recession Probability Model that attempts to predict the probability of a recession over six-, 12-, and 24-month horizons. Our methodology is explained in greater detail on our Forecasting the Next Recession page on www.guggenheiminvestments.com. 2
Taken together, our Recession Dashboard and our proprietary Recession Probability Model, point to the next recession beginning by mid-2020.
Naturally, there are substantial risks that our recession date could be too early or too late. Nevertheless, we believe that successful investing requires a roadmap, as with any other endeavor. Our investment team uses this roadmap to help guide our portfolio management decisions, in order to seek superior risk-adjusted performance over time and across cycles.
Hypothetical Illustration. The Recession Probability Model is a new model with no prior history of forecasting recessions. Its future accuracy cannot be guaranteed. Actual results may vary significantly from the results shown. This illustration is not representative of any Guggenheim Investments product. Source: Haver Analytics, Bloomberg, Guggenheim Investments. Data as of 12.31.2018. Shaded areas represent periods of recession.
Interval Since Last Pullback
While there is a relationship between the days since the end of the last correction and the magnitude of pullback, as shown in the chart, the majority of pullbacks during non-recessionary periods registered declines under 20 percent. As we discussed earlier, pullbacks falling within the 5–20 percent range historically experience recovery periods of one to four months. These are not periods typically associated with severe economic deterioration, and do not necessarily represent a signal to reduce equity exposure. As of the date of this analysis (3.15.2019), there had been 81 days since a non-recessionary pullback of greater than 10 percent.
1Source: Guggenheim Investments. Data as of 3.15.2019.
Putting Pullbacks in Perspective
Pullbacks are often not a time to panic and should rather be used as a reason to analyze and assess. Under certain circumstances, it may even be the case that a pullback represents an attractive buying opportunity for certain portfolios. The benefit of gaining reliable market and economic perspective is essential in preparing for market pullbacks. Rather than act on emotion, it’s important to put these events in context to determine what they mean.
Working with your financial advisor, you may then better assess any potential impact on your portfolio and implement a proper course of action, if any is necessary, that is in line with your investment objectives.
To learn more, speak to your financial advisor about Guggenheim Investments’ timely insights and thought leadership.
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