In this case, there’s a 73.9% chance of seeing a decline of greater than 10% in any year. Our data set, which begins with the inception of the S&P 500, is based on 70 years of data. Lynch’s probability of a 10% or greater drawdown was based on a mixture of indices 1 that included 95 years of data. We flip the y-axis so that one can easily distinguish the greatest drawdown as the tallest column. We then average the max drawdown across years, which is the red line in the graph is below. We then calculate the current return from that peak, selecting the minimum return to arrive at the maximum drawdown of the year. We start by pulling the S&P 500 data and looking at the maximum drawdown from the previous peak of the past 252-day trading period. With that comment as motivation, let’s begin. Indeed, Peter Lynch, the famous portfolio manager of Fidelity’s one-time flagship Magellan fund, was quoted as saying something akin to there’s a 50% chance of a 10% decline or more in any year. Markets are volatile thus there’s going to be a drawdown of some magnitude every year. If you’re expecting predictions, we predict with absolute confidence the market will be volatile over the next three years! Finance humor never gets old.įirst, some perspective. This post is mainly focused on data exploration. But we can offer an historical perspective on drawdowns through the aid of R programming and data science. What’s not is precisely why the market decided now was the time to discount the global impact. The cause for the sell-off was relatively clear: the global spread of the coronavirus. But we do know that applying data science to the recent market turbulence may provide some perspective.Īs of the close of the US market on 2/28, the S&P 500 and many other indices were already in correction mode, which is typically defined as a 10% decline from the most recent peak. We’re not even sure what any of that means. And given the market sell-off we were too busy gamma hedging our convexity exposure, looking for cheap tail risk plays, and trying to figure out when we should go long the inevitable vol crush. Life got in the way of focusing on the next couple of posts on rebalancing. We’re taking a break from our series on portfolio construction for two reasons: life and the recent market sell-off.
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