Are Current Risk Levels For The US Stock Market Extraordinary?

Finally, consider how drawdown stacks up for the S&P 500 through time. At the moment, the market’s at a record high (as of Jan. 15) and so current drawdown is 0%. In fact, drawdowns tend to cluster near 0%, which reflects the market’s tendency to rise and recover after corrections/bear markets. As such, drawdown’s distribution is heavily skewed and so it’s dramatically abnormal from the perspective of a normal distribution context. Relatively deep drawdowns occur, of course, but they’re unusual. Accordingly, the current 0% drawdown is closer to a typical reading vs., say a 20% peak-to-trough decline.

The main takeaway: risk appears relatively modest if not low, but deciding if that equates as typical, or atypical, is challenging since there’s a lot of subjectivity involved. All the more so when you consider that market risk cycles through time and so it’s reasonable to think of “low risk” as a precursor to “high risk” in the near future. Further complicating the risk-analysis task: there are many other metrics to consider, along with different rolling periods. Meanwhile, every investor thinks of risk in a different way that’s unique to her tolerance for financial pain, investment horizon, objectives, etc.

Risk analysis is critical, but ultimately it’s a mix of art and science and so one investor’s idea of a “low” risk reading may look like an accident waiting to happen to another set of eyes.

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