A Historical Look at Market Downturns to Inform Scenario Analysis

Blog post
6 min read
Monika Szikszai, Rick Bookstaber, Thomas Verbraken
November 26, 2024
Key findings
  • Investment managers and asset allocators can benefit from a historical perspective on drawdowns, helping to build confidence in risk assessments and better prepare portfolios for adverse outcomes.
  • We identified 34 U.S. equity-market drawdowns of over 10% since 1946, classifying them into four distinct categories based on their trigger event.
  • Macroeconomic and fundamental catalysts typically led to larger, longer drawdowns, while leverage/liquidity and noneconomic events resulted in faster sell-offs and quicker recoveries.
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
US equity-market drawdowns
Major drawdowns in U.S. equity markets between Jan. 1, 1946, and Aug. 31, 2024. The shaded areas indicate the drawdowns we identified. Source: Fama-French Data Library, MSCI
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
Long-term performance of the US equity market
Evolution of the U.S. equity market's value from January 1946 to August 2024 (blue) and trend line (orange), which has a slope of 7.2% (annualized) return. The shaded areas indicate the drawdown periods we identified. Source: Fama-French Data Library, MSCI
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
Catalyst type

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.

Examples

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

Catalyst type

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."

Examples

1961: Kennedy Slide, shift in investor sentiment and profit taking 1983: Concerns about stretched valuations, profit taking 2000: bursting of the dot-com bubble

Catalyst type

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.

Examples

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

Catalyst type

Noneconomic These events are exogenous and difficult to anticipate and usually become scenarios open to analysis only after they have occurred.

Examples

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.
Drawdown characteristics for different catalyst types
Drawdown characteristics for different catalyst types
Characteristics for events identified between January 1946 and August 2024. The dots show the maximum drawdown, drawdown speed, time to bottom and time to recovery for individual events. The bars represent the averages.
History can inform forward-looking scenarios
An analysis of historical drawdowns since 1946 showed that sell-offs can unfold differently — such as in terms of maximum decline and speed — depending on the type of trigger. This historical perspective can enhance confidence in risk narratives and scenario analysis, helping investors anticipate risks more effectively and adjust asset allocations and portfolios for a range of possible outcomes.
Rick Bookstaber
Rick Bookstaber
Managing Director, MSCI Research
Thomas Verbraken
Thomas Verbraken
Executive Director, MSCI Research
Monika Szikszai
Monika Szikszai
Vice President, MSCI Research

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1 We focus on U.S. equity-market performance and drawdowns since 1946. U.S. equities are represented by the MSCI USA Index starting in 1972, with earlier data approximated using the Fama-French benchmark for the largest market-capitalization quintile of U.S. stocks. Data was retrieved from the Fama-French Data Library on Kenneth R. French's website and is based on: Eugene F. Fama and Kenneth R. French, “Production of U.S. Rm-Rf, SMB, and HML in the Fama-French Data Library,” Chicago Booth Research Paper No. 23-22, Fama-Miller Working Paper, Dec. 18, 2023.2 We identified drawdowns larger than 10%, and registered the peak, bottom and recovery dates. However, sometimes a new event started — caused by a new catalyst — before the market fully recovered. To address this, we manually defined the start or end of certain events. For example, we split the drawdown/recovery from Oct. 9, 2007, to Feb. 14, 2011, into two separate crises, recognizing that the event between Oct. 9, 2007, and May 19, 2008, was driven by leverage/liquidity concerns, while the event from May 19, 2008, to Feb. 14, 2011, had macroeconomic characteristics.3 We have seen similar periods in other equity markets, with Japan probably the most notable example as its equity market reached its previous high (from 1989) only this year. Other markets are still below their peak reached shortly before the dot-com bubble burst (e.g., the MSCI Italy Index is around 30% below its 2000 level). Another cluster of countries is below their peaks prior to the GFC (e.g., the MSCI Spain Index is around 25% below its 2007 level). While findings about the U.S. equity market cannot necessarily be extrapolated to other regions, concepts such as “lost decades” and the categories of drawdown triggers could be meaningful for other equity markets. Data is based on MSCI index levels (price) in local currency.4 Classification of the drawdowns is based on historical context and is subjective to some degree. For full transparency, the full list of events can be found on MSCI's client-support site.

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