There Will Be Drawdowns

By Charlie Bilello

07 Oct 2022

For the first time in over a decade, the S&P 500 is down more than 20% from its prior high on a monthly closing basis (total returns including dividends).

The current drawdown, at nine months and counting, is now the longest we’ve seen since the 2007-09 bear market.

Volatility has been rising all year and now stands well above its historical average.

The number of trading days in which the S&P 500 has fell 1% or more (50) is already at the highest level we’ve seen since 2009, and there’s still three months to go.

By now, the litany of reasons for the market rout are known to just about everyone: war, inflation, tightening monetary policy, and a global economic slowdown. All news seems to be bad news and as one might expect, forecasts of impending doom are running rampant.

During such times, it’s hard to imagine stocks ever going up again. Which is undoubtedly leading many investors to either panic and sell or hold off on investing new money until the “dust settles.” In theory, their reasoning is sound: by waiting for the market “to bottom,” they’ll avoid further downside and be able to buy back in at lower prices.

But in practice, this strategy almost always fails. For if they’re scared to invest today, what are the odds that they will be buyers if prices go down more and the news only gets worse? Not very good. Based on the evidence of investor returns trailing fund returns across all categories, they’re much more likely to do the opposite. The 1.73% annualized “behavior gap” over the last 10 years is a direct result of investors buying high and selling low, again and again.

Data Source: Morningstar

The main problem with trying to pick a bottom during a bear market is that no one knows where the bottom will be, despite the many predictions you hear in the financial news each day. But if you look at the track record of those doing the predicting, you’ll soon find that many of the same people calling for a crash today were forecasting higher prices at the start of the year, and following their forecasts over the years would have led to disastrous performance. Which is why when it comes to the stock market, there’s only one prediction you should ever pay attention to: there will be drawdowns.

Though their duration and magnitude will vary from year to year, drawdowns are the one constant in markets.

If you can accept that and be mentally prepared for them when they come, you can build considerable wealth over time. And importantly, you can do so without the need to time the market by picking tops and bottoms.

To be sure, stocks can still go lower in the short run, and no one should be the least bit surprised if they do. We’ve seen a number bear markets with deeper drawdowns than today (2007-09, 2000-02, 1973-74 to name a few) which means there’s no valid argument suggesting the market can’t fall further.

But with every tick lower, stocks become cheaper, and the risk/reward for the long-term investor improves. If you’re a net saver and your time horizon is measured in decades instead of days, a 20% drawdown like we’re in today should be viewed as an opportunity to reinvest dividends or add new capital at lower prices.

When it comes to the stock market, drawdowns are inevitable. Without them, there would be no forward progress for you can’t have upside without occasional downside. Two steps forward, one step back, repeated throughout history has led to incredible gains for investors over time. It’s how you react to those backward steps that makes all the difference.

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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.

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