Even Strong Stock Market Years Can Get Very Stressful

Stocks declined last week with the S&P 500 shedding 1% to close at 5,204.34. The index is now up 9.1% year to date and up 45.5% from its October 12, 2022 closing low of 3,577.03.

After closing Q1 at a record high, the market kicked off Q2 last week on a sour note. The selling on Tuesday and Thursday had the S&P in a 2.1% drawdown from the March 28 record high.

If you do a Google search, you’ll have no trouble finding news stories backing into explanations for why markets moved the way they did. But trying to draw big conclusions based on the signal from a few days worth of market moves is often a futile exercise.

That said, it’s good practice to remember that the stock market will often fall on its way up.

Long-time TKer readers will recognize the chart below. It’s probably the most frequently shared chart in this newsletter. And for good reason! It’s my favorite visualization of short-term stock market performance.

(Note: If you’re tired of seeing this chart, then that’s probably a good thing. It means that you know the stock market sees lots of volatility, even in years when prices close higher. And just so we’re clear, I plan to keep sharing this chart in future newsletters just as I have in the past. After all, it speaks to TKer Stock Market Truth No. 2. More here, here, here, here, and here.)

Going back to 1980, this chart from JPMorgan’s Guide To The Markets shows each year’s annual return for the S&P 500 in gray and its intra-year max drawdown (i.e., the biggest sell-off from its high of the year) in red. During this period, the S&P has seen an average annual max drawdown of 14% while ending positive in 33 of the 44 years measured. This means that in most years, the market has more than recovered the losses experienced in the max drawdown.

Stomach churning selloffs are normal. (Source: JPMorgan)

So far, we’ve had a 2% max drawdown in 2024, which is historically modest. That is to say, we would need a much uglier selloff for this year to be average.

Does it matter that Q1 was so strong? The S&P 500 gained 10.2% during the period. Unusual strength must be followed by unusual weakness, right?

Truist’s Keith Lerner took a closer look at the 11 times since 1950 the S&P gained more than 10% in Q1. The average max drawdown during the remainder of the year for this sample was 11%. That’s not so bad.

Strong Q1s are usually followed by further gains. (Source: Truist Advisory Services)

Importantly, Lerner also observed that despite the drawdowns, the S&P ultimately registered further gains for the year 10 out of 11 times with an average return of 11%

All that said, there’s no example in the samples above where the max drawdown was as small as 2%. So we should be prepared for worse.

Zooming Out

There are lots of things that may be driving uncertainty and volatility in markets right now, including heightened geopolitical tensions, rising energy prices, and the prospect for higher-for-longer interest rates amid tight monetary policy.

There’s also the issue of it being a presidential election year, which tends to come with heightened volatility before we get more clarity.

Election years can be volatile. (Source: Goldman Sachs)

Some of these concerns will recede. Some may intensify.

As these narratives evolve, you can expect stock prices to swing.

But this is what investing in the stock market is all about. Volatility is the price investors pay for higher returns.

A version of this post was originally published on Tker.co.