When investment decision-makers assess risk — whether in response to an emerging crisis or during routine risk meetings — they construct narratives around the data. Investment managers and asset allocators can look to the long history of market sell-offs for helpful context, to better anticipate future drawdowns and prepare their portfolios for what the future may hold. We found that the speed and recovery of market declines varied based on the type of trigger. Noneconomic events, such as the 9/11 attacks, generally led to rapid losses followed by swift recoveries. Conversely, macroeconomic events typically unfolded more gradually and involved prolonged recovery periods.
Drawdowns are a normal market condition
While many risk models focus on return volatility, analyzing drawdowns provides additional information for risk management and scenario analysis by highlighting the depth and duration of market sell-offs. The exhibit below shows daily U.S. equity-market drawdowns from the previous high, from January 1946 to August 2024.[1] The shaded areas represent drawdowns of more than 10%, from peak to trough.[2]
US equity-market drawdowns
What stands out from this exhibit is that the equity market is “underwater” most of the time: On 92% of all days in this period, the U.S. equity market was below its previous peak. As shown in the exhibit below, however, the U.S. equity market exhibited an annualized return of 7.7% since 1946. Long-term equity-market gains were clearly not driven by steady returns.
Most notably, there are two “lost decades” in this period, where it took a long time for the equity market to permanently recover from significant sell-offs. From the late 1960s, it took more than 10 years for the market to finally move on from the recession and oil crisis for good. Similarly, it was only in 2013 that the equity market left behind the downdrafts that started in 2000 — the bursting of the dot-com bubble, corporate-earnings restatements and fraud and the 2008 global financial crisis (GFC) — to return to its long-term trend.[3]
Long-term performance of the US equity market
Catalysts of market dislocations
We linked 34 crisis events with observed drawdowns, whereby the selection of drawdowns follows a rules-based approach with modest adjustments to account for the historical context. We identified catalysts for each event. In some instances, a new catalyst emerged before the market fully recovered from the previous event. We grouped all events into four distinct categories depending on the catalyst type. Examples spanning the sample period are shown in the exhibit below.[4]
Defining four categories of crisis events
| Catalyst type | Examples |
|---|---|
| Macroeconomic This category includes the economic downturns of recessions, moves into the negative phase of the credit cycle and less severe macroeconomic effects like tight monetary policy or rising interest rates. |
1946: Postwar transition, inflationary pressures and monetary-policy uncertainty 1973: Oil crisis as OPEC imposed an oil embargo, leading to stagflation and recession 2008: Global financial crisis |
| Fundamental These events are characterized by revised earnings and changes in perceived value, such as in the face of earnings surprises or after a period of what former Federal Reserve Chairman Alan Greenspan termed “irrational exuberance.” |
1961: Kennedy Slide, shift in investor sentiment and profit taking 1983: Concerns about stretched valuations, profit taking 2000: bursting of the dot-com bubble |
| Leverage/liquidity These dislocations are price-based rather than fundamentally driven events. They include microstructure events like leverage and liquidity cascades, momentum and shifts in concentration. |
1980: Hunt Brothers forced to sell stocks in attempt to corner silver 1998: Long-Term Capital Management’s collapse and forced selling 2018: Volatility spike leads to rapid unwinding of leveraged positions |
| Noneconomic These events are exogenous and difficult to anticipate and usually become scenarios open to analysis only after they have occurred. |
1950: Korean War, fears of a broader conflict 2001: 9/11 terrorist attacks 2020: COVID-19 pandemic |
There are notable differences between these categories of drawdown in terms of maximum market fall, time to bottom and time to recovery. On average, the events we classified as macroeconomic have been associated with the largest and longest sell-offs, followed by the category of fundamental events. Leverage/liquidity events had a smaller impact on markets, but developed much faster. Noneconomic-triggered drawdowns typically had the fastest rate of drop (measured in percentage loss per month). We should not take these average statistics too literally when applying them to scenario design, as they are based on the U.S. equity market (other markets may behave differently). Additionally, drawdown classification is subjective to some degree and dispersion is significant within categories. Understanding how different triggers can lead to varying outcomes in terms of maximum loss and the speed of drawdown provides valuable context for scenario design, however.
