One of the keys to successful investing is having appropriate expectations. It's one of the reasons SMI regularly writes about what the market's typical experience is like, whether that's short-term or over the long haul. If you know what normal looks like, it's easier to handle the ups and down along the way to that experience.
The stock market experience over the past year has been decidedly abnormal.
Specifically, I'm referring to the complete absence of downward volatility in the market. It's now been over a year since stocks have suffered even a 5% pullback, the last one occurring in the aftermath of the Brexit vote in June 2016. That makes this just the 6th time since 1950 that stocks have gone a full year without at least a 5% pullback.
Looking at calendar years, Ryan Detrick, senior market strategist at LPL Financial, says the average intra-year correction for the S&P 500 since 1950 has been 13.6%, while 91% of all years have had at least a 5% correction. In fact, more than half of all years — nearly 54% — featured a correction of 10% or more.
While it's hard to say this means anything definitive for the market moving forward, it is a little squirm-inducing to recognize just how unusual the current lack of volatility is. And what it continuing would mean in a historical context.
For instance, today's Wall Street Journal has an article titled "Markets’ Steady Climb in 2017 Defies Historic Odds." (It's locked behind the WSJ paywall, but you can open it via this Twitter link.) Here are a couple of key takeaways:
Three major stock-market benchmarks in the U.S., Europe and Asia have avoided pullbacks this year, commonly defined as 5% declines from recent highs. Never in at least the past 30 years have all three indexes — the S&P 500, MSCI Europe and MSCI Asia-Pacific ex-Japan — gone a calendar year without falling at some point by at least 5%.
Of course, 2017 is only a little more than half over, and plenty can change in the back half of the year. But the last time equity markets went this deep into a year without all three of those benchmark indexes suffering at least 5% pullbacks was nearly a quarter-century ago, in 1993, according to The Wall Street Journal’s Market Data Group.
The article looks at each of the major stock indexes in turn. The MSCI Asia-Pacific ex-Japan, for example, sees an average pullback of 20% each year. This year? 2%. And there have only been three years in the last 30 where the largest intra-year decline didn't reach at least 10%.
Europe has a similar story. The average intra-year decline there is 16%, but the largest decline so far this year has been just 4%. For the U.S. S&P 500, if it were to finish this year with its current worst-decline of 2.8%, it would be the second-smallest intra-year decline in the past 60 years. And the article also relates that the S&P 500 has avoided at least a 5% decline in just five of the past 60 years.
Even small-company stocks have seen a stunning lack of volatility. The Royce Funds, which include one of SMI's current Stock Upgrading recommendations, report that the Russell 2000 (which is a widely watched index of small-company stocks) has experienced an intra-year decline of at least 10% in 18 of the past 20 years. The median (meaning middle, not necessarily average) of those declines was -14.2%. This year's biggest decline for the Russell 2000 has been a mere -4.7%.
What does it all mean? It's hard to say. Obviously, there have been a few cases where these averages haven't panned out. In several of the cases cited above, the statistics reach back to a particular year — whether it be 1993 or 1995 or whatever — and you find that while X almost never happens, it did that year and stocks were up 35% (or some other great figure) that year. So it's not as if these statistics mean the market has to pause or suffer through a 5-10% decline.
But returning to the opening point, setting appropriate expectations is half the battle in investing. And the historical numbers clearly say we're well overdue for at least a 5% pullback if not a 10%+ correction. The market so rarely moves this long in one direction without pulling back that we'd be foolish to expect that to continue. While that blanket may feel a little wet today when the air is warm and the sun is shining, hopefully it will be a helpful reminder should the market winds begin to blow again at some point. A market pullback sometime in the next few months not only shouldn't be a surprise, we should expect it.