The legendary investor Sir John Templeton said, “The four most dangerous words in investing are: ‘This time is different.’” In that spirit, the fourth-quarter market carnage conjured up memories of 2008’s drawdowns and ignited debate about the timing of the next recession.
In short order, the S&P 500 Index fell 19% from its late-September peak, vindicating the bears. Liquidity is tightening, stirring calls for investors to prepare for further drawdowns in equities.
But are fears of a U.S. equity market crash warranted?
ClearBridge Investments defines market “crashes” as drawdowns of 20% or more that last longer than one year. By contrast, we define other large selloffs (15% or more) that last less than one year as “pullbacks.” The added dimension of time is important. Many investors can ride out the shorter-term turmoil of a pullback, but they will feel the impacts of a crash much more severely.
Market crashes and recessions typically go hand-in-hand. Crashes typically last three times longer, with drawdowns 2.3 times more severe than pullbacks. Most significantly, crashes are 2.5 times more likely to coincide with recessions, historically.
ClearBridge’s Recession Risk Dashboard tracks key data along four vital economic fault lines: financial, inflation and consumer factors as well as business activity. Analysis of 12 variables within these categories can help determine whether the U.S. economy is heading toward a recession.
The key question for investors is whether the U.S. is heading into an economic downturn. The current dashboard suggests these fears may be overblown: Eight of the 12 indicators are green, four yellow — and zero red. Although three factors switched from green to yellow (yield curve, credit spreads and commodities), the consumer and business segments remain solidly green. The picture our dashboard paints remains quite healthy overall.
Yet many ask whether this time will be different — will a market crash ensue without a recession?
Given the health of the ClearBridge Dashboard, we believe U.S. equity market turmoil will be relatively short-lived. That should render this period a pullback rather than a market crash.