By now even those living under a rock know that October was a brutal month for equities, and while the US briefly entered into a correction, it was global stocks – and especially emerging markets – the suffered the bulk of last month’s beatings.
Last Thursday, we showed “a quite fascinating statistic” from Deutsche Bank, namely that as of the end of October, 89% of assets that the German Lender collects data on for its annual long-term study, had a negative total return year to date in dollar terms. This was the highest percentage on record based on data back to 1901, eclipsing the 84% hit in 1920.
What about at the index level?
Take the broadest, MSCI World index, which after a turbulent February correction had another, similarly large drawdown in October, before starting to recover into November.
But whether one measures the recent peak-to-trough drawdown at 10%, or when measured from the January 26 high at 12%, drawdowns within bull markets of 10% or more (but less than 20%) are not uncommon according to Goldman, which found 22 such corrections – but not bear markets – for the S&P 500 since 1945. In these, the average correction peak to trough is 13% and lasts 4 months.
What did surprise Goldman, is that both the current pullback and that in February have been much sharper than usual in corrections. To be sure, in both cases technical factors likely played a role – systematic strategies linked to volatility and options hedging might have exacerbated downward pressure, balanced funds and risk parity strategies may have suffered from bonds not buffering equity losses and there has been a material momentum unwind within equities. At the same time, vol of vol has shifted higher since the GFC and corrections are sharper and faster as a result
Additionally, there was a significant regional divergence in the recovery from the February drawdown – while the S&P 500 was at new all-time highs before the recent drawdown, non-US equities underperformed materially due to the significant growth divergence YTD. With US growth decoupling from the RoW, helped by US fiscal stimulus, the Dollar strengthened (again both DM and EM FX) and the Fed repricing accelerated, which further tightened financial conditions in EM, according to Goldman’s Christian Mueller-Glissman. In addition the trade war and European political risks have weighed on non-US equity markets.
Which brings us to the question: is this just another garden variety 10% correction in a rising bull market, or is this the start of a bear market?
The answer can be found in the following chart, which shows the average trajectory of the MSCI World from a year before the start of a drawdown, through the actual drawdown and subsequent 10% drop, and then follows the two average paths: one of recovery, and the other of sliding into a bear market.
What the chart shows, is the through today, global stocks are tracking the trajectory of the average bear market almost to the tick. Whether or not this will change will depend on what happens to stock in the next several weeks, when either the MSCI World manages to find a support, or if it will continue to slide, dropping 20% over the next 12 months, and the continuing to slide lower.
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