The Market Drop: December 2021
It's different at the top.
It’s been a really smooth ride this year. Other than a small dip in October, the worst drop we had so far, all year in the stock market, was 5.33%. There have not been many red days.
After the close on 12/1, we sat at a dip of 5.12% for the total US stock market. Large US stocks were down 4.81%, and small US stocks were down 12.08%. Hardly anything to worry about it. A perfectly normal and regular occurrence in the stock market.
However, a 5.12% drop in the total stock market doesn’t tell the whole story.
Take the Russell 3000 for instance. The index represents the entire US stock market. It owns all the stocks. Today, there are 2,717 stocks in the Russell 3000, and it's available as an ETF through BlackRock and Vanguard (the tickers are IWV and VTHR, respectively).
Market cap weighting.
The Russell 3000 is heavy at the top. 25 holdings make up 35% of the entire index. The top five names make up nearly 20%: Microsoft, Apple, Amazon, Tesla, and Google.
On average, the top 25 names are down 10.35%, with a median drop of 8.71%. Only 12%, or three of the top 25 holdings, are down more than 25%. Those are Disney, Mastercard, and Visa.
So, overall, a pretty resilient line up. But a different drawdown story emerges when we look at everything else.
That means the staggering 2,692 stocks that make up the other 65%. And there is some pain down the market cap.
Taking a look at the entire Russell 3000 index, things are a lot less resilient. The average drop, as of 12/1, sits at 27.49%, and the median drop is 21.10%. Both numbers tell us a correction is underway. But that’s hard to see if you only look at the headline numbers.
In fact, 52.5% of the stocks in the Russell 3000 are down more than 25%. While these stocks may not be household names, several of them are high-flying must-own IPOs like Lemonade Inc., a digital-native insurance company. It’s down 76.08%. And Vroom, an online car buying platform, which is down 75.06%. And he fake meat purveyor, Beyond Meat, is down 70.02%.
Thinking of the stock market as an iceberg, there's a lot of individual stock trauma that we’re not seeing. It’s below the surface. But with 35% in only 25 names, the significant volatility of the bottom 65% is having a negligible effect.
A target rich environment.
Now, we are not exactly stock pickers, but for some clients, we hire money managers to do the legwork and pick stocks on their behalf. When there is a big dispersion in performance, there is ample opportunity to pick up good investments at great prices. That’s a tradeoff all investors should be looking for.
To some degree, the dispersion right now is wider than it was in March 2020, when the whole market dropped precipitously, all at the same time.
Today, there’s diversification in the drawdown. A good thing for the prudent investor. We can trim the winners and buy the losers, hopefully stacking the odds in our favor for better future returns.
As we work through our clients' portfolios this year-end, we’re looking for those opportunities, like always. In some instances, it can be as simple as rebalancing back to agreed upon investment objectives and the big picture stock/bond split. In other instances, it means tax-loss harvesting, or even gain harvesting. This allows us to reallocate to what could be a better risk-to-reward positioning.
How much volatility should we expect?
We don’t know the future. No one does. So, we can’t know if recent volatility gets better or worse from here. And to some degree, it makes the most sense to be ambivalent and just stick to your investment and financial plan.
Here is what history has shown (but always remember, past performance does not predict future results).
In the 75 years of modern markets, we’ve had a correction in US stocks, which is a decline of 10% or more, every two years on average. The milder case of 5.0% drops should be expected once or twice per year. True bear markets, which are 20% drops or more, have happened about once every seven years.
Of course, this is for the diversified investor. Stock pickers or concentrated investors should expect to experience a lot more volatility and possibility more frequent and worse drawdowns.
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Adam K. Wright, CFA, CFP®
Adam guides the vision and implementation of Wright Associates fiduciary service approach, and directs the firm's client engagement, service integration, and investment management practices.
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