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Stock Market Downturns

The history of the U. S. stock market demonstrates that every ten years or so it experiences a downturn on the magnitude of twenty-five to fifty percent. It’s very seductive to try to “time” these swings so as to avoid these difficult periods by selling out in advance. I know of no one who has done that successfully and repetitively. In every episode there are some people who “call the crash” in advance and they are touted as gurus. However, you never hear about them subsequently calling the bottom also.

Not only do you have to call the downturn near the top, but you also have to call the rebound near the bottom in order to outperform a buy and hold strategy. Since the market is very hard to predict, this is essentially a fifty percent double probability. You face a fifty percent chance of getting the sell right and a fifty percent chance of getting the rebuy right. Therefore, you have a twenty five percent chance of success (0.5% x 0.5% = 0.25%).

Pursuing this kind of timing strategy invariably leads to numerous false sells. Then you face the dilemma of admitting the mistake and buying back in after the market has gained value while you were in cash, or stubbornly waiting in the station while the train runs down the track.

Staying disciplined while your wealth is dropping significantly is a hard task. The older you are the more difficult this is. However, this is the only sensible course of action. I view this as the challenge we must meet in order to enjoy equity-like returns that double our wealth in a decade or so and triple it in say fifteen years.

Stock Market Downturns: 9 in 9 Decades

October 2007 to March 2009

mortgage crisisA long-feared bursting of the housing bubble became a reality beginning in 2007, and the rising mortgage delinquency rate quickly spilled over into the credit market. By 2008, Wall Street giants like Bear Stearns and Lehman Bros. were toppling, and the financial crisis erupted into a full-fledged panic. By February the market had fallen to its lowest levels since 1997.

S&P 500 High: 1565.15, Oct. 9, 2007
Low: 682.55, March 5, 2009
Loss: 56.4 percent
Duration: 17 months

March 2000 to October 2002

The bursting of the dot-com bubble followed a period of soaring stock prices and exuberant speculation on new Internet companies. Companies with little or no profits had market values that often equaled or exceeded that of established “old-economy” corporate giants.

S&P 500 High: 1527.46
Low: 776.76
Loss: 49.1 percent
Duration: 30 months

August 1987 to December 1987

After a prolonged bull run, computerized “program trading” strategies swamped the market and contributed to the “Black Monday” crash of Oct. 19. Investors were also nervous after a heated debate between the U.S. and Germany over currency valuations, sparking fears of a devaluation of the dollar. As a result the Dow fell 22.6 percent — the worst day since the Panic of 1914. Yet while the days after the crash were frightening, by early December the market had bottomed out, and a new bull run had started.

S&P 500 High: 337.89
Low: 221.24
Loss: 33.5 percent
Duration: 3 months

November 1980 to August 1982

After nearly a decade of sustained inflation, the Federal Reserve raised interest rates to nearly 20 percent, pushing the economy into recession. The combination of high inflation and slow growth — known as stagflation — was a factor behind Ronald Reagan’s victory over President Carter in 1980.

S&P 500 High: 140.52
Low: 101.44
Loss: 27.8 percent
Duration: 22 months

January 1973 to October 1974

Israel’s Yom Kippur War and the subsequent Arab oil embargo sent energy prices soaring, sparking a lengthy recession. The annual consumer inflation rate topped 10 percent. The Watergate scandal forced President Nixon to resign.

S&P 500 high: 119.87
Low: 62.28
Loss: 48.0 percent
Duration: 21 months

November 1968 to May 1970

Rapid-fire growth ended with a mild recession, accompanied by relatively high inflation of about 6 percent annually. The bear market began just as Richard Nixon was elected president after a tumultuous year of assassinations and riots. The weak economy added to a tense national atmosphere dominated by the growing U.S. involvement in Vietnam.

S&P 500 High: 108.37
Low: 69.29
Loss: 36.1 percent
Duration: 18 months

December 1961 to June 1962

The economy expanded, but the Bay of Pigs attack of April 1961 and Cuban Missile Crisis of October 1962 sparked Cold War jitters and a brief bear market.

S&P 500 High: 72.64
Low: 52.32
Loss: 28.0 percent
Duration: 6 months

May 1946 to June 1949

Less than a year after the end of World War II, stock prices peaked and began a long slide. As the postwar surge in demand tapered off and Americans poured their money into savings, the economy tipped into a sharp “inventory recession” in 1948.

S&P 500 High: 19.25
Low: 13.55
Loss: 29.6 percent
Duration: 37 months

September 1929 to June 1932

The stock market crash of Oct. 29, 1929, marked the start of the “Great Depression” and sparked America’s most famous bear market. The S&P 500 fell 86 percent in less than three years and did not regain its previous peak until 1954.

S&P 500 High: 31.86
Low: 4.4
Loss: 86.1 percent
Duration: 34 months

Reacting can hurt performance

An additional danger in jumping in and out of equity investments is revealed in Exhibit 1: Reacting Can Hurt Performance. The data shows how damaging it can be to miss a very few of the best days.

In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s).

Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero.

S&P data © 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month US T-Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.