Santa is not coming to town! Should we worry?

Normally at this time of the year we would be speaking about the so called ‘Santa’s Rally’ whereby the  stock market finishes the year with a nice market uptick fueled by the Christmas positivity and record breaking retail sales.

This time however it is different.

Following a very volatile quarter, the stock market has just recorded its worst Christmas EVE plunge with the S&P500 index falling by 2.7% Monday, marking the first session before Christmas that the broad-market benchmark has booked a loss of 1% or greater — ever. Prior to 2018, the S&P 500 had never declined more than 1% on the last trading day before Christmas.

As we can see from the first graphic below, the index is having the worst decline this month (currently -13.5%) since 1931 when the index closed the year -14.5%.

What has led to this drastic decline?

There are several market dynamics that has set the market to one of the worst declines in history but the ones that has been constant during the year where the nagging concerns that the Federal Reserve is normalizing interest rates too rapidly, and that a continuing tariff dispute between China and the U.S. could devolve and help lead to a domestic recession, as international economies are already showing signs of a slowdown.

What does history shows? Should we worry?

During the quarter, the S&P500 is roughly down 20%.

There have been more than 370 quarterly returns since 1926. If the quarter were to end today, this would be the 14th worst in that time frame.

Losses of this magnitude in such a short period can become paralyzing when trying to think about what happens next. The past is always easier than the present because we know what happened in the past but have no idea what’s going to happen in the future.

Even if it doesn’t offer a perfect road map for what’s to happen next, I do think the past can provide a range of potential outcomes, even though the future always creates its own path.

On the below table we can see the worst quarterly performance since 1926, together with the forward performance over 1, 3 and 5 year following those declines.

Here we can see that the ensuing 12-month, 36-month, and 60-month performance was positive the majority of the time, with nice looking average gains.

Although past returns cannot be considered as a guideline for future results, it can surely provide some positive re-assurances.

When markets decline so heavily, human nature tends to take over and it makes it difficult for people to handle these types of losses. Generally, this turmoil invites us to overreact.

It’s always possible these losses are an outlier…or they’re a sign of things to come and things only get worse from here.

What is known however is that the history of stock market performance shows that the longer you extend your time horizon, the higher the probability you have of seeing gains. This relationship seems to hold following a big down quarter in stocks, as well.

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