![]() ![]() ![]() Effectively, active management, allowing for proper realisation of higher carry, adjusted for security volatility, might shorten recovery times in a pronounced fashion.īut what if we fall into an inflationary era that impacts expected returns? What if risk premia need to rise further and respective troughs across equity and bond markets have not run their full course? At that moment, it serves well to look at asset classes that protect portfolios. That, again assuming with a big question mark that we have observed the trough, means a recovery time of around 6 years and 3.5 years. Both sectors have seen their expected returns (mainly carry + roll-down return) rise markedly towards 2.37% and 3.13%. In EU IG corporate bonds, the drawdown sits at 11% from Augtill May 6. For European EMU government bond investors, the peak-to-trough takes us from Decemtill again May 6, for a 13.6% adjustment. The 15% adjustment for a quality US corporate fund will require about 2.75 years to fully recover, supposing the bottom was reached in early May, with an expected return for the sector that has climbed towards 5.36%. Luckily, with diversification across bond sectors and interest rate sensitivity, on average between 5% and 7%, the outcome for the average bond investor becomes a little less pessimistic. Indeed, with a starting point on 30-year US rates at around 1.20% back in August 2020 versus 3.07% today you get the picture looking at a peak some 33% higher. The key difference in fixed income between today and back then is that recovery times will take longer. ![]() In bond markets, we are going through the worst maximum drawdowns on record as we have to go back to 1980 to witness similar adjustments. On average the recovery in US large-cap equity markets took about 39 months. Historically, recovery times have fluctuated between 16 months (from 1961 peak) and 74 months (from 2000 peak). Post-WWII, taking US large-cap stocks as our guide, maximum drawdowns ranged between -54% and -22%, averaging about -34%. Try not to fall victim to panic or subjective argumentation supporting your decision-making. When investing during stressful moments, it serves to know one’s market history. The iShares 5 to 10-year US Investment Grade Corporate bond index adjusted by 16.60% between the end of 2020 and May 6, 2022. However, looking at the iShares 20-year+ US Treasuries index, which reached a high on August 4, 2020, we observe a brutal adjustment of 33.75% by May 6, 2022. Bear markets in fixed income do not have a standard definition. The last memorable bear market on the Dow Jones took place between October 2007 and March 2009, dropping 54% peak-to-trough. The Dow Jones average counts 33 bear markets between 1900 and today. Equity bear markets are defined the moment peak-to-trough adjustments exceed 20%. Yet, again, it requires courage to look deep into the past in order to face maximum drawdowns that far outpace the current correction. A worst-case scenario is unfolding as we speak, as selling now would lock in a burdensome loss. Imagine that an investor bought heavily into equity over Q4 2021. Maximum drawdown risk for an asset is its greatest historical peak-to-trough decline in value. As markets are confronted with geopolitical, health, monetary, fiscal and supply-demand uncertainty, it can pay to enlarge your scope and include maximum drawdown risk in your overall risk assessment. Making use of this definition as the only standard and widespread notion of risk might lead to tunnel vision. The higher the volatility measure, the higher the estimated risk but also the higher future, expected return estimates. Volatility is expressed as the standard deviation of returns over a set period. Aside from risk defined as permanent loss of capital through default or confiscation, the common measure of risk across instruments or sectors in financial markets has been volatility. ![]()
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