A Long and Cold November

Each time I would return to my home town of Chicago in the winter, after being away for many years, I was always quickly reminded by friends and family how much “my skin had thinned” after complaining about the cold weather. It’s not that I didn’t know the winters were brutal, but being in the moment in the cold triggered a different memory and reality. 
Such can be the same in the financial markets, except unlike the somewhat predictable weather patterns of seasons; we never really know what season it will be in the stock and bond markets. And while we have the luxury of fall weather to acclimate us to the cold of winter, changes in the markets occur much more rapidly and without warning.
The last month or two has shown that some market participants may have become accustomed to very favorable weather in the market, forgetting it what it feels like when things quickly change.

Below is a table that calculates the percentage of trading days the S&P 500 sat in a drawdown in excess of 10%, 20%, and 30%. While some of this will be self-evident remembering that the Internet Bubble and Great Financial Crisis both occurred in the 2000s, it might come as a surprise to some just how tranquil this decade has been, and in particular the last five years.

As shown above, only 2% of the trading days of the last five years have been during a 10% or greater drawdown for the S&P 500, while there hasn’t been any trading days (as measured by closing prices) with a 20% or greater drawdown. What this tells us is that the recent past has been extremely tranquil, and any selloffs have been recovered in fairly short order. The higher percentages since December 2009 reflect the time it took for the S&P to recover from the drawdown that began in October of 2007. In fact, it took until March 28th of 2013 for the S&P 500 to full recover from the drawdown that began in 2007.

This data does not tell us what will happen going forward, but it can be used to remind us how stable markets have performed over recent time periods, and how we may have forgotten what it feels like when the markets not just falls, but stays in a drawdown for a prolonged period of time. Our emotions in situations like the present can help give us cues as far as how much risk we are comfortable taking. Just as a Southern California resident might think they remember what a Chicago winter feels like, it’s quite another thing when it actually arrives. In the case of markets today, the recent drop is historically nothing more than a minor blip on a chart of longer term drawdowns. Constructing a portfolio that allows you to live and feel comfortable through all seasons is important.