Understanding U.S. Equity Market Drawdowns

Equity market momentum is a powerful force. After recovering from a difficult year in 2022, the S&P 500 posted an impressive run of consecutive +20% returns in 2023 and 2024. The U.S. equity market was the envy of the world, benefiting from the resiliency of U.S. consumers who continued to spend and firms flush with cash (largely in the tech industry) that operated at the tip of the spear for AI innovation, integration, and capital expenditures (capex).

Sentiment heading into 2025 was justifiably elevated. The average sell-side strategist had a target price for the S&P 500 north of 6,500, implying returns of over 10% for the year, with a seemingly pro-growth, market conscious administration set to take over in January. The post-election sugar rush soon turned to angst as whipsawing tariff policies reduced visibility for businesses both large and small. Though tariffs remain a key concern, other fundamental headwinds from lofty earnings expectations, stretched valuations, and market concentration also began to play a role in the deterioration of the equity market rally.

Investors are again being reminded, albeit painfully, of the risks that come with investing in a momentum-driven market. U.S. equities broadly have gotten the short end of the stick as trade tensions have started to escalate, leading to a reversal of their prior leadership. Last week, the S&P 500 dipped into correction territory, dropping more than 10% below its mid-February all-time high (Figure 1). Investors became used to relatively low market volatility in recent years, though we are reminded that the volatility we are experiencing at present is not out of the ordinary. In fact, it should be expected.  

Figure 1: S&P 500 returns year to date 

^{Data as of March 14, 2025. Source: Bloomberg.}

^{Past performance cannot guarantee future results. Indices are not available for direct investment. Investment in a security or strategy designed to replicate the performance of an index will incur expenses such as management fees and transaction costs which will reduce returns. There is no assurance that any investment strategy will be successful.}

Anatomy of a drawdown

During the last 35 years, distinct drawdowns of over 10% have occurred 13 times, or roughly once every three years. However, the drawdown period itself can last months. The 10% threshold, while somewhat arbitrary, is a useful barrier between typical market movements and a more sustained period of pressure. As one might expect, drawdowns coinciding with recessions tend to be steeper and more severe than in non-recessionary periods. Though there are fewer examples of recessionary drawdowns over the analysis period (four in all), the market pullback has on average been 2.7x larger than a non-recessionary drawdown (Figure 2). Additionally, the average drawdown period (from peak to trough) was nearly four times longer in a recessionary backdrop as the market struggled to find a bottom. It is for this reason that our investment process is led with economics.

Figure 2: Recessionary versus non-recessionary drawdown analytics (1990-present)

^{Data as of March 14, 2025. Sources: Bloomberg, WTIA.}

Volatility in the equity market is normal and can help the equity market achieve a healthy reset before moving to new highs. Using history as a guide, corrections of 5%–15% are quite common outside of recession. In fact, the average drawdown in any given calendar year (since 1990) has been -13.7% while the average drawdown in a year when the S&P 500 delivers a “positive” return is still -8.3% (Figure 3). Since putting pen to paper, the S&P 500 has bounced +2% higher on March 14, after shedding more than $5tn in market cap over the prior four weeks. We continue to anticipate that elevated volatility and policy changes coming from Washington will be defining characteristics of the “chutes and ladders economy.” 

Figure 3: S&P 500 calendar year return and intra-year drawdown (1990-present)

^{Data as of March 14, 2025. Sources: Bloomberg, WTIA.}

^{Past performance cannot guarantee future results. Indices are not available for direct investment. Investment in a security or strategy designed to replicate the performance of an index will incur expenses such as management fees and transaction costs which will reduce returns.}

Looking ahead

The U.S. equity market may have found its footing, at least for now, finishing last week with a strong rally. However, recent headlines have done little to calm investors’ nerves. Trump’s cabinet members have conceded that there may be some short-term turmoil ahead to accomplish the administration’s longer-term economic goals. It also appears that the president may be less focused on the market as a barometer for his policies in his second term.

The market has reacted decisively to both the political and economic developments, sending sensitive areas of the market (such as cruise lines and airlines) lower, while strategists have rushed to slash their year-end price targets. Gold, fixed income, and more defensive-oriented sectors (such as health care and utilities) have outperformed while investors are waiting for the dust to settle.

Core narrative

Our Investment Committee has been gradually reducing risk since late last year. We reduced small-cap equity exposure in client portfolios in November 2024. In February of this year, we closed our U.S. large-cap equity overweight. Both risk reductions were based on the view that investors were no longer being compensated with adequate margin of safety for taking excess risk. Client portfolios are now allocated with a neutral allocation to our strategic benchmark across asset classes.

Our economic baseline continues to call for a slowing economy, slightly below 2% trend growth, and disinflation toward the Federal Reserve’s target by midyear. However, we acknowledge that recession risks have moved higher. We currently project a 35% probability of a recession in the next 12 months. Assuming trade-related uncertainty does not derail spending plans, we anticipate positive economic growth, albeit at lower levels.  The labor market remains a key point of attention, especially as Department of Government Efficiency job cuts filter through into the economic data. We view the rapid pace of policy change another reason to stay diversified, and we anticipate that the news cycle could become more muted as we move through the year.  

^Glossary

^{A drawdown is the peak-to-trough decline of an investment, trading account, or fund during a specific period. It can be used to measure an investment's historical risk, compare the performance of different funds, or monitor a portfolio's performance.}

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