The anatomy of Nasdaq 100 drawdowns and investor psychology

Every drawdown has its unique cause and comparisons should be made with great caution, but when you face a drawdown of meaningful size you need to get your statistical prior right. The current drawdown is the 15^th largest since 1 January 2003, so while it has felt dramatic to many investors it is still a benign correction. The median and mean drawdown length of these 15 drawdowns are 121 and 157 trading days respectively, so the current drawdown could extend for 6-9 months if this is an average drawdown.

What is important to investor psychology is the drawdown length. This was one of the main reasons retail investors left the equity market after the dot-com bubble burst. Investors are impatient people despite many argue they invest for the long term. The drawdown after the financial crisis in 2008 and the subsequent unemployment rate was also detriment for retail investor participation. Even has late into the current bull market as 2016 and 2017 you can find many articles on where the retail investor is in equity markets, and whether they will ever come back. There are also many mentioning of young people and women nor participating.

But the last couple of years bull market, improving labour market dynamics, a larger focus than ever by media on technology stocks, the rise of crypto and Tesla, have pulled many young people and women into the game of equity investing. Many arrived during the rebound phase last year when many people were forced into lockdowns. This means that a lot of the new marginal buyer of technology stocks have never seen a drawdown and not a drawdown of proper length. Therefore our thesis is that if this becomes a lengthy drawdown in technology stocks due to higher inflation and interest rates, then it will alter the investor psychology of growth investing and many will become impatient and shift strategies or maybe even leave the market. It is only really fun when returns come fast and easy.

The chart below shows the 15 drawdowns and their recovery profile. The blue line is the recovery after the Covid-19 pandemic started the historic sell-off last year. This is still the fastest recovery ever in history from such a large drawdown that reached 27.7% at the bottom and a recovery that took many quant strategies and tactical asset allocation strategies by surprise. The orange line is the current drawdown and something we will be monitoring for some time as it shapes investor psychology.