Beware, the markets go down often!

Because we are long-term investors, we will frequently face market downturns. To better prepare ourselves for these unpleasant but inevitable declines, it is good to study the history of the stock market declines.

Looking at the US stock market, on average this is what we see:

Here is another view of the declines in the US stock market. The black bars represent the yearly gains (or losses). The red dots show the intra-year declines i.e. how much did the market fall off its peak in that year.

Because the market fluctuates a lot, there are intra-year declines every year. Even though in the majority of the years, the market ends the year with a gain. Many of these declines are in single digits i.e. less than 10%. However, when the stock market delivers a negative year-end return, it is usually accompanied by an even bigger intra-year decline. For instance, see years 2000-2003 or 2008 where both year-end and intra-year declines are in double-digits. This is expected when the stock prices are moving down.

More interesting is how there were some positive-return years where intra-year declines were quite large – greater than 10%. This was when the stocks were recovering from a large bear market – see years 2003 and 2009-2012. In each of those years, the market fell by double-digit and then went on to double-digit gains by the year-end. See this table:

Now put yourself in an investor’s shoes who has just suffered through the 2008 market crash. What would you have done when the market declined by another 28% by the middle of 2009? Would you have bailed out then? Or during the next three years (2010 – 2012) when the market again declined by double digits – only to see positive gains by the end of each year.

During those years, the financial media was of no help either. If anything, it exacerbated the prevailing fears and concerns of the time. Here is a selection of CNN Money headlines/excerpts from that era:

I was fully invested when the market went down in 2008. I was still nursing my wounds when the market declined by another 28% by March 2009. It was all gloom and doom in the financial media. Little did we know that it was actually the beginning of a strong market recovery that would go uninterrupted for the next eight years.

The mainstream media is not in the business of thoughtful prognostication. Its primary goal is to attract eyeballs. To catch readers’ attention, it feeds on popular sentiment. During the 2008-2012 period, the market’s mood was predominantly gloomy and fearful. Unsurprisingly, the news headlines of that period were also mostly depressing. If an investor were looking for some signs of optimism back then, he’d have to look really hard. There were not many. If I had been taking my investing cues from the media, I would have bailed out of stocks back then. Many inexperienced investors did just that.

The stock market goes down every year – sometimes it’s just a small blip of less than 10%, other times it may go down 10% or 20% – and on occasions even 30% or 40%. A majority of the times, the market recovers quickly – as is evidenced from the chart above. Other times, the market could continue declining for several years in a row.

Could I (or you) as an investor discern which way the market will go after it has declined 20%? Probably not. And it’s not just us. Even expert investors can’t tell with high degree of confidence. The mainstream media can’t do it either. Thus, for us long-term investors, the best approach is to ride out market declines.  Don’t panic and don’t pay attention to the financial press. Stocks are volatile but only in the short term. Give yourself three to five years – most bear markets don’t last even half that long.

I limit my reading (and watching) mainstream financial media mostly to news – rather than opinions. Most opinion pieces (and even news items that cover expert opinions) are not predictive of future market direction. Everyone once in a while though, one might come across a prescient opinion piece. For instance, in October 2008, Warren Buffett wrote this op-ed piece for New York Times: “Buy American. I am.” Needless to say that his advice therein, though largely ignored by investors and media at the time, was very timely and prophetic.

The exception doesn’t deny the rule though! By and large, you’d be better off not paying attention to the expert-heads that appear in the financial press – unless you are familiar with their prediction history. After all, would you trust a stranger with your money?

Related:
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