by Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial
Additional content provided by Colby Hesson, Analyst, Research.
This latest bout of market volatility has been unsettling, especially after such a calm 2023 and 2024 for stocks. However, with the benefit of some historical perspective, volatility of this magnitude is quite common.
That said, Monday morning's brief spike in the CBOE Volatility Index (VIX) to over 60, which we wrote about in "Navigating the Storm: Insights on Current Market Volatility", was certainly not normal. Now that this measure of implied volatility based on S&P 500 option prices is back to more normal levels in the low 20s after closing at 38.6 on Monday, it’s fair to say this pullback has been typical. We explain below.
The S&P 500 has just experienced its second 5% pullback of the year. The maximum year-to-date drawdown (peak-to-trough decline) is just 8.5%. On average, the index experiences three drawdowns of between 5% and 10% each year. Corrections of 10–20% are also quite common, having occurred once per year on average. So, 2024 is not shaping up to be a typical year.
One of our favorite charts illustrates this point. Since the 1980s, the S&P 500 has experienced a maximum intra-year correction of 14%, on average, while the index has produced an average gain of 13%. Though this latest pullback happened fast and felt significant, history suggests it really was not. In fact, this widely followed large cap index is barely over halfway to the average drawdown. Even in up years, the average maximum drawdown is 11%, so we are not even there yet. After stocks rebounded yesterday and this morning, the S&P 500 is less than 7% off its July 16 record high.
S&P 500 Intra-Year Corrections
Source: LPL Research, FactSet 08/06/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.
Even in election years, the volatility profile doesn’t seem much different. Since 1950, the average maximum drawdown for the S&P 500 during election years has been 12.8%. We may still get there given the economic and political/geopolitical uncertainty and seasonal weakness, but the point still holds. This volatility is normal. It’s like paying a necessary toll on the road to attractive long-term results.
For the chart below, we added the average gain in the S&P 500 one year after the election-year lows. At 21%, we think it’s fair to be optimistic about a rebound in stocks this year after interim lows are set. Historical seasonal analysis suggests those lows are likely to come in September or October.
Post-Election Rallies Tend to Follow Modest Election-Year Corrections (1950–2024)
Pullbacks and Performance One Year off S&P 500 Lows Based on Four-Year Presidential Cycle
Source: LPL Research, FactSet 08/06/24
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. The modern design of the S&P 500 was first launched in 1957. Performance before then incorporates its predecessor index, the S&P 90.
Summary
Elevated volatility and stock market drawdowns can be unnerving, but the market tends to reward individuals who stay invested, are patient, and do not panic. LPL's Strategic and Tactical Asset Allocation Committee (STAAC) maintains its tactical neutral stance on equities while actively monitoring signs the bottoming process is playing out. While we remain cautious, potential triggers for a stock market recovery include Fed signals that they may be more aggressive with rate cuts, more evidence that the U.S. economy is not falling off a cliff, and stability in the global currency markets — particularly regarding the volatile Japanese yen. Markets may also refocus on company fundamentals and share buybacks in the coming weeks as the rest of corporate America reports second-quarter earnings. Finally, most sentiment indexes reflect pessimism, which have historically been bullish contrarian indicators.
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