This Too Shall Pass

October 28, 2022

This has been a challenging year for investors. Equity markets have declined significantly, with most indices well within “bear market” territory (at least 20% lower than the previous peak). Fixed income markets have also had a historically bad year, which has reduced the typical diversification benefits of balanced portfolios.

Quadrant’s previous newsletter Where is the Bottom? published in June discusses the investment environment and factors that have been influencing the capital markets this year – namely inflation and interest rates. These two forces remain highly relevant today. Readers that are interested in better understanding the effects of inflation on capital markets are encouraged to read the June newsletter.

The current economic landscape has brought forward talk of an inflation driven recession. This newsletter will provide some clarity around what a recession is and its potential impacts. It will also provide some context in terms of the current market cycle, and reinforce why long-term thinking remains paramount for investors.


The generally accepted definition of a recession is when a country experiences two or more successive quarters of negative growth in gross domestic product (GDP). In other words, a recession is a general decline in economic activity. While recessions can range in severity depending on a multitude of factors, they usually include a decline in industrial and agricultural production, trade, incomes, stock markets, consumer spending, and employment levels.

The main risk for the majority of families during a recession relates to employment. A contracting economy may mean that businesses are experiencing reduced revenue and profits, which may in turn result in increased layoffs or diminished job prospects for those in the labour force. This risk is not as applicable to those who are already retired or are financially independent.

Another notable impact that people generally experience during a recession pertains to their investment portfolios. Portfolios typically experience negative returns and heightened volatility during recessionary periods. If a particular investor’s portfolio design does not adequately consider withdrawals from the portfolio to fund a planned purchase or ongoing lifestyle expenses, the impact of recession-based volatility and negative returns could be permanent.

Aside from maintaining an adequate cash reserve or “emergency fund”, which should be a part of any portfolio design, the truth is there is not much else one can do during a recession but ride it out. While recessions are an expected part of the business cycle, they cannot be reliably predicted in terms of timing, duration, or severity. It is only with hindsight that recessions are officially declared, as economic data is backward looking and reported on a lag. Capital markets, on the other hand, are forward looking and are influenced in part based on expectations of where the economy is going. For this reason, equity market cycles tend to bottom-out and recover well before the actual economic cycle.

Your portfolio design should not be altered unless there is a material change in personal circumstances. A proper portfolio is designed to meet long term personal objectives and endure economic and market cycles over time. Further, if history is any guide, periodic down cycles represent an opportunity to deploy long term capital at more attractive valuations.

Down Market Cycles

The well-known S&P 500 Index, which broadly represents the U.S. large-cap stock market, has returned -24% (in U.S. dollars) from its peak on January 3, 2022 to the end of the third quarter (September 30, 2022). While this is certainly a notable drawdown, it is not unique or unusual.

Prior to 2022, the S&P 500 has experienced negative returns of 24% (or more) eight different times in the post-war period beginning 1946. During these eight down cycles, the average return from the market top to the eventual bottom was -37%. In terms of cycle length, it has historically taken about 13 months on average to reach a bottom. Note that no two market cycles are exactly alike and past performance is no guarantee of future performance.

Using the S&P 500 as a proxy for a diversified equity portfolio, there has never been a period of negative returns that has not eventually recovered and surpassed the previous market peak over time. While market down cycles can create anxiety, the good news is that they are usually much shorter than up cycles. Using the same eight periods noted above, the up cycles that followed lasted 9 years and experienced almost 500% in cumulative returns on average.

With regards to 2022 performance so far, equity markets could certainly keep falling from here – it is impossible to know how much lower or how much longer until the bottom. In the context of a long-term portfolio, down cycles are temporary and at current levels, equity markets arguably offer more opportunity than the start of the year. Valuation multiples have become more attractive and future return expectations have increased.

The following chart revisits the other times the S&P 500 has experienced a negative return of 24% or more and shows what annualized performance has looked like from that point forward. The following 1-year period has on average returned 22%, with only one instance posting a negative return (following the 2007 to 2008 time period). Annualized returns for the following 3-, 5-, and 10-year periods have been double-digit positive on average, with no individual cycles showing negative performance. More importantly, in absolute terms, the index recovered to its most recent peak within an average of 27 months.

Down Years are Normal

Over the long term, equity markets offer higher average returns compared to “safe” assets like cash or guaranteed investment certificates (GICs). Based on historical experience, the journey towards achieving a higher long term average return also entails time periods of volatility and negative returns along the way.

The average annualized return for the S&P 500 since the beginning of 1946 is 10.9%. The individual years that make up that average, however, have ranged from -37% to +52%. Shorter and less frequent periods of negative returns are simply a fact of life for investors in the capital markets. The S&P 500 has shown negative performance in 2-3 out of every 10 calendar years on average.

This Too Shall Pass

Periods of negative returns cause all investors pause, especially after the very positive years in recent memory. New investors who have entered the market during the past year or two may be feeling especially anxious as they did not benefit from those “good” years.

As human beings, it is natural to have an emotional response when experiencing losses or portfolio declines, even if only notionally. Unfortunately, this emotional response often clouds the judgement and decision-making abilities of an investor. This is why an Investment Policy Statement (IPS) is essential. An IPS identifies specific investment objectives, takes into account the unique circumstances of the investor, and provides structure that can help guide investment decisions and actions over time.

During turbulent periods like this, it is worth remembering that markets have been here before and will be here again. Investors are encouraged to reference their IPS, resist emotionally driven decisions, and focus on the long term as opposed to the short term. Discipline and patience are required in order to achieve long term success.

This too shall pass.




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