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Historical drawdowns and recoveries: Considering comparative performance

This article takes a deep dive into the resilience of key stock indices by examining the historical drawdowns and recoveries of the S&P 500, NASDAQ, and ASX200. We explore the reality of significant market downturns, shedding light on the true nature of stock market fluctuations and the ability of these indices to recover from deep declines.

At the end is a graph and table comparing these major indices to MSP’s models. We encourage investors to consider comparative performance as a key aspect of risk vs reward; crucial for any investment decision.

Understanding Market Drawdowns

Market drawdowns, representing the peak-to-trough declines, are a stark reminder of the stock market’s volatility. They play a critical role in highlighting investment risks and assessing market conditions, especially during times of economic uncertainty.

1. S&P 500’s Struggle in the Global Financial Crisis

Between October 2007 and March 2009, the S&P 500 plummeted by approximately 57%, a consequence of the subprime mortgage crisis. This event marked a significant downturn, the likes of which hadn’t been seen since the Great Depression. It took the index a solid four years to claw back to its pre-crisis levels, a recovery achieved only by 2011.

2. The NASDAQ and the Dot-com Bubble Burst

From March 2000 to October 2002, the NASDAQ experienced a drastic 78% drop in value, following the burst of the dot-com bubble, driven by rampant speculation in internet-based companies. It was a lengthy 15-year journey for the NASDAQ to recuperate to its pre-2000 heights, a milestone it finally reached around 2015.

3. ASX200’s Encounter with the Global Financial Crisis

The ASX200 faced similar challenges as the S&P 500 during the global financial crisis, enduring a 54% drawdown from November 2007 to March 2009. The recovery phase for the ASX200 was even more extended than that of the S&P 500, with the index requiring about a decade to exceed its 2007 peak levels, marking a substantial period of recuperation.



Balancing Risk and Reward: The Return-Drawdown Ratio

In the realm of investment decision-making, a key metric to consider is the ratio of total return to maximum drawdown. This ratio is instrumental in providing a clear view on the interplay between reward and risk. It juxtaposes the overall return with the largest drop in investment value (drawdown). A higher ratio is indicative of a more favourable balance, suggesting that the potential returns better compensate for the risks involved. On the other hand, a lower ratio may point to a situation where the risks may not be justified by the expected returns. Investors are encouraged to utilise this ratio as a guiding principle to tailor their investment strategies in line with their risk tolerance and financial objectives.

Comparing major markets with MSP models:
Drawdown Tot. Growth (incl divs) Return vs Drawdown Largest historical DD Largest DD recovery time Future Outlook Active downside protection
S&P500 28% 10% 0.36x 57% 48 mths Highly questionable ?
NASDAQ 38% 15% 0.39x 78% 180 mths Highly questionable ?
ASX200 (incl. divs) 10% 15% 1.50x 54% 100 mths Highly questionable ?
MSPV 0.5x 8% 33% 4.06x 8% <6 mths Undeterred Yes
MSPV 16% 65% 4.06x 16% <6 mths Undeterred Yes
MSPV 2x 32% 130% 4.06x 32% <6 mths Undeterred Yes

 

“If you understand how the economy works, it works just like a machine. There are cause-effect relationships.” – Ray Dalio

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