Setbacks Set Up Comebacks?
2022 was a year characterized by volatility across many asset classes, and both stocks and bonds experienced some of their worst drawdowns in history. However, in recent months, there have been signs that a return to normalcy may be underway. Inflation has started to fall from its October peaks. This disinflation is being driven by a variety of factors, including the normalization of China's economy, changes in supply chains, falling commodity prices, and a decrease in consumer demand. In fact, 59% of the components of the Consumer Price Index (CPI) are currently in deflation. The VIX, a gauge of the market's expectation of future volatility, has also fallen below 20, indicating that investors are less fearful.
Historical data is also on the side of investors. As the chart below shows, 84% of the time, the annual return following a negative calendar year is positive. Additionally, over half the time, the return exceeded 20%. Despite the volatility of 2022 resulting in one of the worst annual performances of the S&P 500 index since 2008, it seems like things are about to make a turn for the better.
Setbacks Set Up Comebacks?
Source: Bloomberg, Redwood. Data as of 1/20/2023.
While there are many reasons to be optimistic, the reality is that equity markets still fell by 19.4% in 2022. Due to the math of loss, to break even, the market would need to recover by 24.13%. And although there is a decent probability that 2023 will be a positive year, there is no guarantee that this will happen. It is entirely possible that we see a year like 1974 or another post-tech bubble, where the market fell for a second year in a row and the losses exceeded 20%. This highlights the importance of mitigating drawdown risk from an investment management standpoint. Investors who were able to avoid the drawdown of 2022 are in a much better position to benefit from a possible recovery than those who rode out the entire decline.
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Disclosure: This piece is for informational purposes only and contains opinions that should not be construed as facts. Information provided herein from third parties is obtained from sources believed to be reliable, but no reservation or warranty is made as to its accuracy or completeness. Charts and graphs are for illustrative purposes only. Discussion of any specific strategy is not intended as a guarantee of profit or loss. Past performance is not a guarantee of future results. Objectives mentioned are not guaranteed to be achieved. Investors cannot invest directly in any of the indices mentioned above.