Michael Mauboussin: Drawdowns Are The Unavoidable Cost of Long-Term Investing

Michael Mauboussin from Morgan Stanley Investment Management have published a comprehensive analysis examining stock market drawdowns and recovery patterns from 1985 to 2024. The research reveals that even the most successful investments experience severe price declines, with the median stock suffering an 85% drawdown that takes 2.5 years from peak to trough.

The study analyzed over 6,500 companies and found that more than half never recover to their previous highs. Michael’s work demonstrates that large drawdowns are an inevitable feature of equity investing, affecting individual stocks, mutual funds, and even portfolios with perfect foresight.

He provides case studies of NVIDIA and Foot Locker to illustrate how similar magnitude drawdowns can lead to vastly different long-term outcomes. Their analysis includes practical guidelines for evaluating whether a deeply discounted stock might recover, emphasizing the importance of distinguishing between cyclical and secular business challenges.

Here are the key takeaways:

• Drawdowns are inevitable and severe: The median stock experiences an 85% decline from peak to trough, taking 2.5 years to reach bottom, with over 54% never recovering to their prior highs.

• Bigger drops often mean bigger bounces: Stocks with maximum drawdowns of 95-100% show median annual returns of 295% in the first year after hitting bottom, compared to 47% for stocks with smaller declines.

• Perfect foresight doesn’t eliminate pain: Even a portfolio constructed with godlike knowledge of future winners would still experience a 76% maximum drawdown, highlighting how difficult drawdowns are to manage psychologically and professionally.

• Context matters more than magnitude: NVIDIA and Foot Locker both suffered ~90% drawdowns, but NVIDIA recovered due to cyclical industry factors while Foot Locker faced secular retail decline, leading to vastly different outcomes.

• Recovery evaluation framework: Investors should assess whether fundamental issues are cyclical vs. secular, examine the basic business unit economics, evaluate financial strength and capital access, and determine if management acknowledges challenges honestly.