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Last week my friend and great technician, Jonathan Krinsky, CMT shared a really interesting chart and table pointing out the extreme bifurcation of the market at the March 2000 peak. As an example, he pointed to show the Bank Index was down 28.94% during the same period where the Nasdaq 100 rose 97%. By the peak in the market four sectors had already fallen by 14%-29%. This got me thinking more about the drawdown data that I often share in my Thrasher Analytics letter and occasionally on Twitter.
As of Friday (Nov. 19th), the average S&P 500 was down 9.8% which is just a day after the index had made a new all-time high. One great example the dot-com bubble taught us is the market can run much longer on fumes of a handful of stocks or a single sector before the selling in individual stocks finally breaks the proverbial camel’s back. So let’s take a look at the drawdown data from prior major market turning points and see if we can draw any conclusions.
There’s many different ways to approach the drawdown topic. Today I’m looking at not just the average drawdown of large cap stocks but the average drawdown between three sectors: Consumer Discretionary, Financial, and Technology. These aren’t the largest weighted sectors but I feel give a good representation of the ‘risk on’/offense nature of the market.
To quantify the drawdown data, I’m using a 1yr percentile for the average of the above mentioned sectors. When the percentile is low, it tells us that the figure has been declining over the last year, specifically when we reach the 60th %tile. Pairing this method of relative evaluation with an absolute figure of -10%. There’s nothing magical about 10% but tells us the average of the three sectors has declined by at least double-digits, which is significant. We’re looking for periods of time when the market was at least 0.5% from a 52-week high, meaning the index is basically at a high while the average drawdown is in a bearish trend and absolute level.
When doing this study, I set these two parameters before actually looking at the results and found the only times since 1995 the criteria was met was 2000, 2007, and 2018. With that, we’ll look at all three of these periods of time.
2000
First, the peak of the dot-com period, shown on the chart below. Our criteria of an average drawdown of 10% and below the 60th %tile began being met in November of 1999 and again in January and lastly in March of 2000. By the final peak in the S&P 500 the average of XLY, XLF, and XLK stocks were down -14.2%. This echoes the point Jonathan made about the extreme divergence in performance of individual equities and industries by the time the market eventually peaked.
2007
Next let’s look at the peak that led to the Financial Crisis in 2008. The fireworks started more in ’08 but the peak occurred in ’07. Only one day met the noted criteria and the divergence in performance wasn’t as severe as during the late 90s but the average drawdown was right around -10% by the peak in SPX but had been worsening for about five months as the index kept rising.
2018
The fourth quarter of 2018 brought a mini-bear market, breadth was weakening most of the summer and the indices began to reflect this weakness into the last three months of the year. Many stocks peaked back in January and after the 10% decline in February and March weren’t able to fully recover. Eventually the drawdown data got bad enough where our three sectors had an average of -10.2% in September and then -12% in early October.
Today
How’s the data look today? We haven’t met the criteria of an average drawdown for the three sectors of -10%, as of Friday the average was 8.8%. The percentile is low at 44th, with the data having peaked back in late April. The average Consumer Disc. stock is already down -10% with tech not too far off at -9.2%.
Hopefully we don’t see this data weaken further. Currently equity seasonality is bullish with stocks traditionally doing well in the last two months of the year. This seasonal tailwind could help pullback up some of the weak stocks negatively impacting the drawdown data.
Conclusion
So are we setting up to repeat 2000, 2007, and/or 2018? Based on drawdown data we aren’t there yet but it does appear the data is weakening.
This review of market history was to show that while there’s been some major extremes in data (dot-com bubble), the useful of drawdown data can be a great tool for evaluating the health of individual stocks. While % above moving average and new high/low lists are common and popular tools for breadth, they require either two inputs (price and a moving average) or overly focus on key dates (new low over 52wks, 6months, etc.). By simply looking at the raw price data of how stocks on average are declining (or not) we can pair the drawdown figures with other tools of analysis in evaluating the market, something I do on a daily and weekly basis.
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