(Invesco) The Grateful Dead sang, “… when life looks like easy street, there is danger at your door.” To the naysayers, investing in 2021 has seemed too, well, easy. Among the most common questions we received this year was, “When is the drawdown coming?” For what it’s worth, rounding out the top five are: How high will bitcoin go? (I don’t know.) Will inflationary pressures moderate? (I believe yes, over time.) Are the supply-chain challenges easing? (If you squint hard enough you can see signs of progress.) And finally, what is wrong with the New York Giants? (This deserves its own blog.)
Drawdowns vs. corrections
The answer to whether a drawdown (less than 10% decline) is coming has always been an easy one. Sure. Drawdowns are always coming. Since the early 1980s, there has been a greater than 5% drawdown in the S&P 500 Index in every year but two (1995 and 2017). Even in 2020, which had felt relatively benevolent until late December, the S&P 500 Index experienced a 5% drawdown in September, before climbing to an all-time high on Dec. 10. For all the excitement around the latest drawdown, as of Dec. 20, the broad market is still less than 4% from its all-time high, although some higher profile technology and “reopening” names have fared far worse.
On the other hand, corrections (declines of greater than 10%) happen less frequently. Corrections tend to not emerge out of nowhere. Often, they are the result of policy uncertainty. The market has currently gone since June 29, 2020, without an official correction, coinciding with, not surprisingly, a 385-day period of mostly straightforward monetary policy. The US Federal Reserve (Fed), until recently, had been steadfast in its support for the economy. The current run is the longest stretch without a correction since December 2012–August 2015 (690 days) and February 2016–February 2018 (516 days). Both of those spans ended with, you guessed it, the Fed signaling multiple rate hikes ahead.
Could we face a correction?
So, is there danger at our door? Admittedly, there are challenges. The Fed is poised to raise interest rates in a slowing economy with a new, highly contagious coronavirus variant emerging. If there were ever a time for a market correction, this could be it, although few careers have been made accurately predicting corrections. Even if it were to occur, one should view it in the proper perspective of a market that has been up 51% since June 2020.
More importantly, we see few signs that the current business and market cycles will be ending any time soon. Despite the recent market volatility, financial conditions remain very easy. The typical tell-tale signs of a recession — a meaningfully flatter yield curve, substantially wider credit spreads, a significantly stronger US dollar — are simply not evident. The bond and currency markets appear to expect inflationary pressures to ease in the coming year as growth moderates, providing cover for the Fed to ultimately back off its tightening stance. I tend to agree. If that turns out to be the case, then any near-term drawdown or correction would likely prove to be a short-term deviation on a longer-term advance.
Over time, to borrow from another Grateful Dead song, we suspect that the market “just keep(s) truckin’ on.”
