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11. S&P 500: Returns Based on Time Until Next Recession

[Chart Legend: Blue Bar = Median 6m Price Return, Green Diamond = % of Positive Price Returns (rhs)]

[Chart Data]
Average 6m Price Return (Left Axis) / % of Positive Price Returns (Right Axis)
31 to 36 Months Prior to Recession: 3.7% Return
25 to 30 Months Prior to Recession: 4.4% Return
19 to 24 Months Prior to Recession: 5.8% Return
13 to 18 Months Prior to Recession: 6.4% Return
7 to 12 Months Prior to Recession: 4.5% Return
1 to 6 Months Prior to Recession: -5.7% Return

Source: Investment Strategy Group, Bloomberg.

Of course, none of the supportive factors discussed above precludes further bouts of equity volatility. As we highlighted at the beginning of the year, the historical probability of a 5% or greater correction from current valuation levels was 96%. Yet these statistics alone do not justify underweighting equities, since such pullbacks often occur after sizable equity rallies, as this year reminds us.

Moreover, such pullbacks are quite normal historically. After all, stocks have suffered a median of two pullbacks of at least 5% and one of at least 10% per calendar year in the post-WWII period, leaving both the frequency and magnitude of this year's dips in line with past experience. Most importantly, years that experienced a similar number of pullbacks as 2018 nonetheless ended with a median gain of 6% and had 77% odds of a positive return.

Conclusion

Although we have painted a less alarmist view of recent market weakness, we are by no means Pollyannaish. While bull markets do not die of old age, they do become more susceptible to ailments over time. Yet as we survey the tug of war between the steady factors and the unsteady undertow, we do not think the balance of risks is strong enough to topple the ongoing US expansion and the continued growth of corporate earnings it supports.

That said, this viewpoint does not preclude further market volatility and the market may still make new lows if the current downdraft persists. But history suggests the bull market is likely to continue until about 5-6 months prior to the end of this economic expansion. Thus, it will take a significant increase in the odds of an imminent recession to provide the trigger—that has been lacking thus far—to tactically underweight equities. In the interim, we continue to recommend that clients maintain their strategic allocation to US equities.

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