An Unprecedented Recovery

 

Article Summary:
    • The steep, -20% drop that took place in the market at the end of 2018 has been followed by an unprecedented, equally interesting recovery.

 

    • Long-term trends in the market are up, but not so much to where caution should be thrown to the wind.

 

    • The stock market can trick us into thinking it’s going to crash, but the metaphorical “tornado sirens” need to be respected in order to protect our hard-earned retirement savings.

 

    • In sports, there is a saying that goes, “No matter how good a team may be, anyone can beat anybody on any given day.” When it comes to the market, the offense has the ball, but anything can happen at transitionary times such as this, and it pays (or should I say “saves”) to be cautious.

 

So far, 2019 has been an interesting year.  When combining the depth and velocity of the -20% drop that took place between September 21st and the end of 2018, and then compare it to the steepness and speed of the recovery thus far, it has truly been unprecedented.  As you can see in the chart below, there is only one year that looks even remotely similar:

No one knows what the future will hold, but in our office, we implement a trend-following strategy.  We don’t predict trends, we follow them… and when the trap door opened below the market’s feet in mid-December (see the chart below), the tornado siren was screaming at us, signaling that it was time to get to the basement before things got out of control.

We never know if the trend is up until the market starts trending up (profound, I know).  This is why you cannot anticipate trends before they happen.  For this reason, it took six weeks before we started getting back into the market the day after Valentine’s Day.  For now, Christmas Eve looks like the bottom, but we won’t really know until several more months have passed.

Right now, the long-term trends are back up and there are few reasons not to be invested in the market today.  While I’d define the area below in yellow to be an area of “caution” for now, still think reward is favored over risk, long-term.  I do think that a mild pullback would be completely normal and healthy in the short-term, but if a possible pullback turns into something worse, there’s a saying in the investment management world that goes like this, “From failed moves in one direction come fast moves in the opposite direction.”  In other words, it would not be advisable to turn a blind eye and throw caution to the wind here.

The last thing I wanted to share today looks more complicated than it is.  The bars below are the total annual return for the market in each calendar year going back to 1980.  The dots (and negative returns) in the lower-half reflect the biggest intra-year loss within calendar year.  So to use 1980 as an example, while the market was up +26% that year, it was also down -17% at one point during that 12-month period. 

In addition, I highlighted 1995, 2017, and 2019 (in the table above) for a reason.  In 1995 and 2017, the total intra-year decline was only -3%.  Talk about shallow volatility and an easy ride!  This year so far, the only decline has been -2% (and the average intra-year drop is -13.9%).

Does that mean that we’re destined for a guaranteed -12% drop this year?  Definitely not.  I could end up being the lowest volatility year in history, for all I know.  Of course, we could also see a correction this summer as well, all depending on what the Fed does (or doesn’t do), the pending trade deal with China, and a number of other factors.

In the end, however, all that matters is whether the trend is up or down.  The markets have a positive bias, which means that stocks trend upward roughly 75% of the time.  The 25% of the time when we see catastrophic market drops, such as the time periods below… this is what we’re aiming to avoid:

For now, the long-term trends are decisively up, confirmed by positive momentum, so until the market tells me otherwise, the offense has the ball.

Till next time…

Adam

Categories: Adam Koos, CFP®, CMT®, Market Commentary

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