The latest plunge in the US stock market left the S&P 500’s drawdown at a bit more than 10%. That’s the amount of red ink that brings usually out the “correction” label. The latest slide has also inspired fresh chatter about the possibility that a bear market is near, which is widely defined as a drop of 20%-plus.
Compared with the market’s placid bull run in recent history the rebound in volatility looks threatening. But for the moment the longer-term view of performance hasn’t changed much in recent days. The trailing 3- and 5-year annualized returns for the S&P 500, for instance, have barely budged relative to recent history.
The current drawdown is a bit of an outlier vs. recent history, but a correction of this magnitude is hardly unusual.
Perhaps the only surprise is that the latest downturn was delayed for so long. A simple econometric measure of bubble risk for the S&P 500 has remained elevated for a year (above the 90th percentile) – until now, of course. The current reading, courtesy of the market’s sharp drop this month, has fallen to a middling 51%, the lowest in three years.
Meantime, there’s still no sign that a bear market has started, based on modeling the numbers with a Hidden Markov Model (HMM) via one-year returns for the S&P.
What might tip the scales over to the dark(er) side for the stock market? There are no shortage of possibilities, including rising interest rates, the outlook for a higher federal budget deficit, and an array of geopolitical risks that continue to churn. In fact, none of this is new. Rather, the difference now is that the crowd has decided to pay attention to the negatives after long spell of ignoring them.
The main source for optimism remains the upbeat macro trend for the US economy. As long as recession risk remains low, there’s a case for thinking that downside risk for stocks may be limited from here on out. All bets are off, however, if the incoming economic numbers paint a different picture than the one we’ve been viewing in recent history.
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