"Kee" Points with Jim Kee, Ph.D.

  • Market Pullbacks
  • Election Year Returns


Market Pullbacks

Markets (Dow, S&P 500) were down over 4% last week and have pulled back over -5% since hitting their peaks a few weeks ago. Recent strong performers like the tech-heavy NASDAQ indices and small cap indices are off even more from recent peaks. Year-to-date markets are positive in the U.S. and negative for most of the rest of the world. Reasons for the sell-off have ranged from President Trump’s comments on the Federal Reserve and trade with China, to IMF reports downgrading global growth, to mid-term election concerns of an impeachment movement should Democrats sweep the House and the Senate (not the consensus scenario). I think strategist Jason Trennert’s take, though somewhat unsatisfying (Barron’s) is probably best, “the proximate cause for the market’s dip reflected mainly a desire to book profits in the big winners."

Market declines like these are very normal. For example, Yardeni Research notes that we’ve had 23 declines of -5% or more in the past 31 years, of which 3 turned into bear market declines of 20% or more. Believe it or not, counting up how many -5% or more declines occur in any given year is pretty hard to do and somewhat subjective. For example, if a market falls -5%, pauses, and then falls another -5%, is that two -5% declines or one -10% decline? How long does a pause in between declines have to be to make each a distinct episode? One day? A week? Some researchers (e.g. American Funds) use a 50% recovery of lost value to distinguish one decline from another. By that measure, and using data going back to 1900, the market averages about 3 pullbacks (i.e. declines greater than -5%) per year, and averages one correction (decline greater than -10%) per year. A “bear market” occurs about once every 3.75 years. Others (J.P. Morgan) use a slightly different methodology and find the market averages about one -5% decline per quarter, or 4 pullbacks per year. Perhaps even more importantly, Morningstar research shows that in years with double-digit stock market declines, the majority (63%) end up positive for the year.

Election Year Returns

What about mid-term election years like the one we’re in? Well, on average at this point in the year U.S. markets are up about 90 basis points (.9%) in mid-term years, which is below this year’s 240 basis point (2.4%) year-to-date performance. And typical mid-term years tend to have a strong post-election bounce, finishing up 6.1% for the year on average. So it is worth restating that market declines like the one we are currently experiencing are normal, “expected but not predictable,” as we like to say. The bigger threat to investor well-being is to believe (and act) otherwise, that is, to believe that market declines are expected and predictable.