Increasing concern about China’s economy, accompanied by a surprise albeit modest devaluation of the yuan currency, helped trigger a sharp drop in global equity markets in late August, with the S&P 500 falling 12% from its high reached just a month earlier. This marked the first 10%-plus correction for the U.S. market since 2011, an unusually long stretch given historically a correction occurs roughly once a year. (There have only been two longer stretches without a correction, in the early to mid-1990s and the mid-2000s.) The S&P 500 has had a 10%-plus correction 52 times since the end of World War II. They are not unusual. Investors should be prepared to experience such drops repeatedly over their investment lifetime.
Given the market’s historical pattern of corrections, we’ve mentioned the potential for a market decline in each of our last three quarterly investment commentaries. So we weren’t surprised it happened. But that’s not to say we were predicting it would happen or what the triggers or catalyst might be. Short-term market predictions are a fool’s errand, and history doesn’t exactly repeat. But a knowledge of market history and cycles is useful for putting the present moment into context and thinking through different potential scenarios, risks, and investment opportunities.
It’s also worth noting in this context that, based on our analysis, since 1950 the S&P 500 has suffered a 20%-plus decline nine times—the common definition of a bear market. Put differently, bear markets have historically happened about once every five years on average. The current market has gone more than six-and-a-half years. The longest stretch without a 20%-plus decline was the 12-plus years ending with the bursting of the tech stock bubble in 2000.
Coming back to the present, the S&P 500 bounced briefly from its August 25 low but dropped an additional 2.5% in September, ending the quarter down 6.5%. This marks the first negative quarterly return for the index since 2012; again, an unusually long span of positivity.
Developed international stocks, as measured by the Vanguard FTSE Developed Markets ETF, also dropped 12% intraquarter, from high to low. For the quarter as a whole, they were down 9.7%. European stocks did a bit better, losing 8.5% in dollar terms and 7% in local-currency terms.
Emerging-markets stocks fared the worst, dropping 21% from their intraquarter high in early July to their low on August 24. For the quarter, the emerging-markets stock index was down 18%. That return includes several percentage points of losses to dollar-based investors from the continued depreciation of emerging-markets currencies against the U.S. dollar.
Given the broad negative environment for global stocks, let alone that much of the angst was driven by disappointing developments in China, it’s not surprising emerging-markets stocks had the worst downside performance. While we have viewed (and continue to view) emerging-markets stocks as attractive over our five-year and longer investment horizons, we have also assumed they are riskier (higher beta) than developed market equities and will suffer larger short-term losses in a negative macro scenario for various reasons (e.g., due to concerns about slowing global growth).
Our recently established position in managed futures funds performed well during the market downturn, both in absolute terms and relative to a mix of stocks and bonds. Returns for the funds we use ranged from flat to gains in the mid- to upper single digits. Of course, this is a very short period and while we do expect managed futures funds to perform well during extended stock market downturns, that won’t necessarily be the case over shorter periods.
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