Despite The Assumed Causes Stock Market Correction Still Within Normal Bounds

After a long period of low volatility a correction feels like a crash but at this point it is within normal bounds.

Below is a daily chart of S&P 500 since 1960 with maximum drawdown from all-time highs on a closing basis shown in the indicator pane.

After the close of yesterday (02/08/2018) the drawdown from the all-time high was 10.1%. The average since 1960 is 11.68%. Therefore, the current level of the drawdown is well-within normal bounds. Actually, the maximum drawdown reached 14.16% in February 2016 and current drawdown is about 28% lower than that one.

The same observations are valid in the case of DJIA below:

The current drawdown level of 10.35% is less than the average since 1960 of 10.78% and much lower than the drawdown reached in February 2016 of about 14.5%.

Sometimes I wonder why when it comes to momentum and other ambiguous notions people use long-term charts but when it comes to drawdown they do not. Below is a chart of DJIA since 1910 that shows an average drawdown of 23.65, which is skewed of course by the Great Depression.

Drawdown levels above 23.65% have been common in the last 40 years and include the 1987 crash event but the market upward bias was not affected.

Obviously, history may not a good guide of what will happen in the future due to possibility of regime change. But regime change identification is hard and on the other hand most investors won’t believe it is happening even if there told. Therefore, everyone is on their own here. If there is no regime change, then the market will resume its uptrend in the future. If there is a regime change, then we may see sideways or bear market activity for many years into the future. I will not argue against one or the other. That is everyone’s homework to do.

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