Market drops are never pleasant to experience. But they are neither so rare as to be considered a “black swan”, nor so predictive of impending doom as to be considered a “canary in a coalmine”.
Volatile world stock markets in May 2010 have rekindled a degree of nervousness among investors fearful that the steep drop portends further deterioration of their portfolios. A few days in particular have brought back painful memories of the bad old days of late 2008 and early 2009. Market watchers will recall that at that time, the major world stock indices lurched 5% to 10% or more between the highs and lows of a single trading session with disturbing regularity. Daily market movements can often be attributed to noise; they tend to self correct. Monthly moves, too, are very short term, and should be viewed with a skeptical eye. But they coincide with the opening of client statements, and thus have a particular prominence.
In May, the TSX Composite index was down “only” 3.67%, but other stock markets were worse, and the world’s most watched index, the Dow Jones Industrial Average (DJIA), was off almost 8%. The venerable DJIA has a long history, and it is instructive to look back over the years for a broader view.
In a readily available dataset reaching back to October 1928, we have 979 calendar months of return data for the DJIA. 110 of the months prior to this one saw returns worse than -5%, a figure that includes 31 months worse than 10%. So these months are hardly rare, occurring a bit more than 1 month out of 12. Admittedly, the 1930s had more than its share of these occurrences with 32, while the 1980s and 1990s were relatively quiet on this front (notwithstanding the October 1987 crash!) with 9 and 8 respectively. The 2000s seemed to be a return to longer term averages, where there were 16 such periods, many still in relatively fresh memory.
It is also important to note that the big drop months do not provide guarantees with respect to the direction of future returns. The 110 big drop months above have been followed by positive returns for the next 12 months 61.8% of the time, a figure that is within respectable distance of the overall positive 12 month return ratio of 66.1% after the other months in the data.
Neither swan nor canary, how shall we categorize market drops? If they can be compared to any bird, it would be the turkey: noisy, full of angst and served up on seemingly an annual basis.