A common argument used against tactical asset management in favor of more passive approaches is that the market always comes back.
We applaud the optimism. However, we believe building an investment portfolio that assumes the market will always come back is like putting all the chips on black in a game of roulette. It’s also a terrible way for financial advisors to approach risk management in their client portfolios.
Defining ‘Always Comes Back’
At Blueprint Investment Partners, it is our nature to ask questions and precisely define terms.
The obvious question here is: Do markets truly always come back? The argument against making active, meaningful portfolio shifts in reaction to changes in the market is rooted in a belief that such moves can sometimes be counterproductive since, historically, stocks tend to rebound from declines rather quickly. The argument further posits that missing out on the rebounds can impact an investor’s ability to meet their financial goals. As the argument’s thinking goes, it is wise to ride out these declines and even to contribute more during these periods.
As for the terms:
The market can of course mean many things, but it’s likely your mind immediately went to stocks. Ours does too.
Tactical asset management can also mean many things. In this case, we are talking about a type of active investment strategy that involves meaningful, systematic (i.e., programmed and repeatable) shifts between various assets, from aggressive (usually equities) to conservative (such as short-term bonds).
Always come back relates to the time required for a market to return to its all-time high (ATH) after a decline. It can be measured from a previous ATH or any other point. Some financial professionals believe declines of less than 10% don’t meet the definition of a correction and thus would focus only on the time to recover from a 10% decline to a new ATH. An even stricter definition measures from a bear market definition of 20% decline to a new ATH. However, for our analysis, we are primarily sticking with the broadest definition, measuring from one ATH to the next, irrespective of the decline in between.
The Modern U.S. Investor Experience
For pretty much every U.S. investor alive today, the idea that the market always comes back appears to be generally true.
In the last seven decades, the longest period between ATHs (dividends excluded) in the S&P 500 Index is approximately 7.5 years.
Time Between All-Time Highs in the S&P 500 – Last 70 Years
| Year Drawdown Ended | Length of Drawdown (Years) |
| 1980 | 7.5 |
| 2007 | 7.2 |
| 2013 | 5.5 |
| 1972 | 3.3 |
Source: ICE, 1/1/1954 to 12/31/2023
If you start the clock at a correction of -10%, it doesn’t materially impact the time to ATH. Changing the definition to a bear market decline of -20% also doesn’t materially affect time to ATH. The recovery period after a large bear market to reach a new ATH was two years on the short end and less than 7 on the long side.
From this, can we conclude that the market does indeed always come back? If we were seeking other evidence, what else might we look at? We decided a prudent next step would be to further test the “always comes back” argument by looking at:
- A second modern dataset
- A historical U.S. dataset
Looking Abroad for A Second Modern Dataset
We believe Japan is a financial ecosystem that is somewhat equivalent to the U.S. market in its maturity and characteristics. It allows us to further think about the “always comes back” argument with another modern experience.
The Japanese benchmark index, the Nikkei 225, recently experienced its first ATH (dividends excluded) since 1989 – staggering, in our view! It took almost 35 years before Japanese investors saw values return to the pre-internet, pre-cell phone – pre-CD? – age.
Compounding matters is that the maximum decline in the index has been approximately 80%. Imagine being a financial advisor who’s trying to keep clients in their seats with that set of facts.
Amazingly, as of the end of 2023, the Nikkei was still in a 14% drawdown from the 1989 high, meaning another 16% return was needed to get back to its ATH. As a result, the phrase “always comes back” is likely a somewhat insulting concept to Japanese equity investors.
Looking Back Nearly 100 Years for a Historical Dataset
As a final test of the “always comes back” argument, we can look further back in U.S. records to the inception of the S&P 500 data in 1928. This allows us to consider the experience of the pre-modern U.S. investor.
The last 70 years have included relatively short declines, though sometimes severe, and the average time to recovery was 4.9 years. However, directly preceding the last 70 years, there was a 25-year stretch where the S&P 500 failed to make a new high and fell as much as 80% from its peak in the late 1920s into the early 1930s. It wasn’t until 1954 that the market made a new ATH.
While the market did eventually come back, imagine what the experience would have been like for an investor or financial advisor during a 1930s- to 1940-style decline. We imagine it would have felt a lot like the advisor with a client significantly exposed to the Nikkei.
Low Cost Associated with Having an Answer to, ‘What if the Market Doesn’t Come Back?’
In our view, the above datasets cast doubt on the idea that markets always come back.
Others may argue we’re trying to compare apples to oranges, that the U.S. and Japan are too different to be compared or that the U.S. system today is different from the 1950s. We applaud the optimism and hope for their sake they are right.
We simply aren’t comfortable putting all our chips on black. We think that’s too much risk for us to take on as an asset management firm, to ask our advisor partners to take on, and ultimately than what is in the best interests of our advisor’s clients – especially because we believe there’s a way to mitigate this risk.
We’ve conducted research that we believe shows how a systematic tactical approach to asset management could have benefitted investors with significant Japanese equity exposure, a pre-modern U.S. investor, and even the modern U.S. investor. We are happy to share this data for those that are interested – please reach out.
Furthermore, our research leads us to conclude that there’s a low cost associated with having an answer to the question, “What if the market doesn’t come back?”
The team at Blueprint Investment Partners is passionate about our systematic investing approach and would love to discuss both the data that supports our perspective and any insights you might bring. With nearly 20 years of research and hands-on experience in asset management, we value opportunities to continue learning and to share our findings.
