Actually, scary is kind of normal

After almost two years now of economic and social upheaval, what was once weird starts to feel normal – and what was normal now seems weird.

The markets got rather bumpy over the past few weeks, and with words like “omicron,” “inflation” and even “recession” floating around, a downward lurch in the S&P 500 can look especially scary.

But – and I know this is a little counterintuitive – a more volatile market actually indicates a return to normalcy. Despite all the turmoil going on elsewhere, 2021 was almost freakishly stable for the US stock market as a whole.

To illustrate what I mean, let’s first consider what’s typical for the “intra-year peak-to-trough drawdown” – that is, the range between the highest and lowest points of the market in a given year, which gives us a snapshot of how volatile the year was overall.

Since 1950, the intra-year drawdown for the S&P 500 has hit…

  • 5% or worse (i.e. greater) in 65 out of those 70 years.
  • Between 5-10% every 2-3 years on average
  • 10-20% every 5 years on average
  • Over 20% every 6-7 years on average.

Meanwhile, the single largest drawdown for all of 2021 was (drumroll please)… 5.2%.

In other words, 2021 lands in the top 10% for intra-year market stability. But in addition to giving investors smooth sailing, it also gave them great returns – the S&P 500 hit a new all-time high 70 times over the course of the year.

That’s more than the entire decades of the 1970s and 2000s combined (which also gives you an idea of just how dismal those periods were). But it also stacks up nicely against more recent years:

S&P 500 number of new all-time highs for years 2013-2019

So basically, we just lived through one of the easiest years in stock market history. Strange as that may seem.

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But don’t get too comfortable. While it might be an overstatement to say that market cycles and corrections run like clockwork, they’re nonetheless fairly regular. As finance blogger Ben Carlson observes, “when markets become too calm, investors can become complacent. This can lead to overreactions and increased volatility down the line.”

In other words, don’t let the cushy conditions of last year make you excessively jumpy when something inevitably goes wrong again. That will just make things worse. Keep your cool, and remember that volatility and productivity are not mutually exclusive.

Here’s a favorite chart of mine from JP Morgan, which compares the biggest peak-to-trough drawdown each year on the S&P 500 (red dots) to its total return for that year (gray bars):

Sure, there are a few ugly outliers in which high volatility accompanied major losses. But the exception proves the rule – note that even 2020, as much of a dumpster fire as it was, still managed to end up ahead. If that’s not encouraging, I don’t know what is.

— Graham