The Pullback Has Begun

By Kostya Etus, CFA®, Chief Investment Officer, Dynamic Investment Management

A couple of bad weeks and the stock market falls into negative territory for the year (as measured by the S&P 500). That said, it is still up double digits from a year ago and it will take more than a couple weeks to derail this bull market. The leading drivers of market weakness have been the mega-cap tech stock darlings that everyone has come to love over the last couple years (known as the Magnificent 7: Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, Tesla), while value stocks squeezed out a positive return.

Additionally, international markets maintain their strong returns this year. Lastly, the bond market seems to have found its footing with strong returns last week, capping off seven straight weeks of positive returns (as measured by the Bloomberg Agg). Overall, the outperformance of value vs. growth, international vs. domestic, and bonds vs. stocks translates into favorable outcomes for globally diversified, balanced portfolios.

Looking at the primary divers of the pullback, we identify three factors:

1. Economic Slowdown. First off, we are coming off a very strong year, with GDP growth of 2.8% in 2024. But over the past month we have been getting a slew of economic data coming in below expectations: retail sales, purchasing manager index (PMI) and initial jobless claims to name a few. Additionally, a key recession indicator has once again been activated as the spread between the 10-year and three-month Treasury yields turned negative.

All of this said, it simply indicates a drop in momentum as we come down from high growth to more normal levels.

2. Trade Uncertainty. President Trump has implemented a series of tariffs with key trading partners including Canada, Mexico and China, as well as proposals for new tariffs on Europe. This could very well spark a tariff war as those countries raise retaliatory tariffs on the U.S. However, the problem is that the tariff noise may be weighing on corporate confidence. For example, businesses may hold off on capital investments and overall spending until the dust settles, which may result in ripple effects throughout the economy and markets.

All of this said, while there may be some price increases and temporary slowdowns, tariffs themselves may be less impactful in the longer-term for the overall economy given other offsetting pro-growth policy measures.

3. Consumer Confidence. Consumer and investor confidence is falling to period lows in the face of inflation worries, policy uncertainty, market volatility and weakness in key growth stocks. Essentially, investors have been waiting for the risk-off environment that would cause the seemingly invincible Magnificent 7 stocks to falter. Given these stocks tend to trade at very high valuations, if a correction were to happen, these stocks may be the hardest hit. And given they represent a key component on major indexes (like the S&P 500), it could have broader implications for the markets.

All of this said, severe market corrections often happen in periods of euphoria where confidence is at extreme highs; given we have a “wall of worry” in place, any correction may be less pronounced.

What’s next? There are several factors which are still supportive of a strong economy and markets, including: strong corporate earnings, broader artificial intelligence (AI) adoption, inflation remaining in a downward trend and labor market strength. Until we see more significant deterioration of economic growth, other than simply moderating from a strong starting point, there does not appear to be a high risk of a strong recession or a severe market drop.

What’s the most common yearly stock market return?

We often say that the stock market historically returns about 8-12% per year. But how often has it been in that range? And how rare are the returns we exhibited the last two years of being up more than 25% or losing close to 20% in 2022? The answers to these questions may help investors manage expectations about stock market returns and be better prepared for the future. For example, it may be beneficial to understand what stocks do after they have had a great year.

To help answer these questions, let’s look at the distribution of calendar year returns dating back to 1926. You may be surprised by the results:

1. Almost Never 8-12%. The percentage we quote most frequently turns up the least. This is both the beauty and the risk of the markets; they are volatile and very unpredictable. That said, the idea behind this range is the fact that investing is a long-term game. So yes, in any given year the returns could be all over the place, but if you zoom out at the big picture, about 10% per year is where you land.
2. Many Above 20%. An astounding 38 out of 99 observations are above 20%. This is by far the largest category for range of returns. And there are only six observations of less than 20%, so the strong returns are overwhelmingly positive. That said, the second largest observed range is 0% to -20%, although 20 observations are almost half of 38. Perhaps most importantly, investing after a great year (above 20%) has resulted in an average annual return of +10.5%, this is a hair better than the overall average of +10.4%. Thus, it may not matter as much what happened last year; the market always looks to the future.
3. Better Than a Coin Flip. Overall, there are 73 total positive returns. This means that more than two thirds of the time, the market is positive. That is certainly more than a coin flip and an additional reason to always stay invested. Again, the long-term game is how you beat the house at the game of markets.

 

Stay diversified, my friends.

 

Range of Returns for Stocks by Calendar Year
Average Annual Returns, Jan. 1, 1926, to Dec. 31, 2024

Source: BlackRock’s “Student of the Market,” January 2024 edition. Morningstar as of 12/31/24. U.S. stocks are represented by the S&P 500 Index from 3/4/57 to 12/31/24 and the IA SBBI U.S. Lrg Stock Tr USD Index from 1/1/26 to 3/4/57, unmanaged indexes that are generally considered representative of the U.S. stock market during each given time period. Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. Investors cannot invest directly in the index.

As always, we recommend staying balanced, diversified and invested. Despite short-term market pullbacks, it’s more important than ever to focus on the long-term, improving the chances for investors to reach their goals.