I’m hearing some concerns about the stock market the last few weeks from the general public. After all, the U.S. stock market (S&P 500 Index) closed yesterday about 12.5% lower than it started the year.

I’ve been consistently warning about extreme stock market valuations that make severe, sharp drops more likely. But the experience so far this year is not yet that severe, sharp drop I’ve been warning about. In fact, the decline so far is quite unremarkable in the context of history.

Let me illustrate…

Below is a chart produced by J.P. Morgan Asset Management showing calendar year returns (gray) AND intra-year declines (red) going back to 1980 for the S&P 500.

Notice that the average intra-year decline is 14%. This means that on average the market declines from some point in the year to another point in the same year by 14%! So, the current 12.5% decline is still less than the average intra-year decline over 42 years.

We also notice that there were 23 years out of the 42 listed where the S&P 500 declined by 10% or more in the calendar year. So, over half the time the U.S. stock market has lost over 10% within a given year.

If there’s anyone out there who is really bothered by what’s happening in the market, that may be a sign they have too much stock exposure as the current year decline, so far, isn’t particularly notable. A full blown bear market is likely to produce far greater losses.

Perhaps what has made this year’s decline feel more painful than other similar declines is that bonds are also falling so there really hasn’t been too many places to hide.*

Whereas Treasuries might typically be appreciating, or at least holding steady in this environment, both treasuries and corporate bonds have been losing ground along with stocks. In fact, the Bloomberg Barclays Aggregate Bond Index is down about 5.7% for the year as well! So, even well-diversified and conservatively-positioned portfolios are down on the year.

*Note: Commodities and the U.S. Dollar have been a couple positive performers this year among a few other asset classes.

 

Hopefully this helps to provide a realistic perspective on the markets and helps set realistic expectations.

Investors don’t really know their true risk tolerance until it is tested in adverse markets. Everyone loves risk when markets are going up because more risk means more returns in those environments. However, more risk means more losses in the second part of the market cycle.

This is why I focus so much on trying to find not only investors’ emotional capacity for risk but also their financial capacity for risk by relying heavily on stress tests I include within clients’ financial projections. I wrote about this concept here: https://melottefa.com/capacity-for-risk/

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