I came across an interview that CNN’s Poppy Harlow did with Warren Buffett in September 2018. She said investors were worried about cracks showing in the U.S. economy after a long nine-year run. And then she asked if Buffett was worried about an imminent recession (4:50). To which Warren replied that America had been on a 242-year run. It got interrupted from time to time but he hadn’t the faintest idea when it might happen again. Whether it was nine-year old run or nine-month old run, an interrupt could happen any time but he wasn’t worried. He said that the economy eventually takes care of itself (13:00).
That interview was done a couple of months before the stock market’s December dive. Today, as the first quarter just ended, the markets had staged a near-complete recovery from that drop. In fact, the S&P 500 is on the brink of reaching its all time high once again — today it’s barely a few percentage points below it.
The market was already down by about 5% before it went into a sustained decline in November, dropping down to 10% and then 15% level. And then on the day after Christmas, it dropped to 20% below prior peak before recovering. 20% drops are commonly considered bear markets. By that definition, the S&P 500 did enter a bear market (albeit for less than a day) on December 26th.
Why did the market panic so quickly in late December? Perhaps it was concerns about the economy slowing down. Or the trade conflicts. Or Fed’s monetary tightening. Ken Fisher suggested it might be due to the failing hedge funds liquidating their positions before year-end. We don’t know for sure. Even if it’s knowable, it’s not really important. Not to long-term investors, any ways.
Most market experts are not calling this recent drop a bear market. Stocks did not close at or below the 20% threshold — they only briefly touched the 20% low intra-day before recovering. Nevertheless, too many investors panicked and worried about a big bad bear market around the corner. It’s as if they were still fighting the last war. After all, we’ve had two dramatic prolonged bear markets in the last twenty years.
While we are on the subject of bear markets, I looked into the trusty Guide to the Markets compendium published every quarter by J.P. Morgan to see the past history of bear market declines. Here’s a chart I pulled from the set:
The top graph shows the S&P 500 declines from prior peaks. The deeper the grey region of the graph, the larger the market decline. It’s a bear market whenever the graph drops below the 20% red line. Similarly, the wider the grey region, the longer that decline lasted. Naturally, whenever the market dropped way below the 20% threshold, it took much longer to recover from it. But recover, it did. Every single time!
If you look carefully at the chart, there have only been three major extended bear markets in the S&P 500 during the last fifty years. The first one started in 1973 and took seven years to recover. The other two both occurred in this century. The first was the 2000 recession where stocks took six years to recover. And the second one was in the 2008 Great Recession that lasted for five years. Note that the chart shows the S&P 500 price returns — not total returns (where dividends would be counted). If we consider dividends, the last two bear markets were a little shorter. By about six months each. As I pointed out in a previous blog post (Revisiting the lost decade), even that lost decade of U.S. stock market (2000 onwards) wasn’t nearly as bad if investors were reinvesting dividends.
You can also see from the chart that there were many other shorter market drops too. Two that stood out because they were considered bear markets were (1) the 1987 flash crash and (2) the early 1990 recession. Both times, the market declined by more than 20%. In the 1987 drop, it took just one year for it to recover to the previous high. In case of the 1990 recession, it took even less time — just six months to recover.
As for the latest decline we had in December, it appears as a tiny grey sliver on the right edge of chart. It almost seemed to touch the red horizontal line but it didn’t. In fact, that December 26th drop to 20% was so fleeting that I couldn’t catch it either. I was awaiting the market to drop below 20% so I could deploy my next dry powder tranche in stocks. I had already done my first two stock purchases — a 10% buy when the market dropped 10% and then another 20% purchase when it breached the 15% threshold. I spelled out my dry powder purchases in the fourth quarter update here.
However, those five-plus-year market declines don’t mean it would take that long for an investor to make money in his portfolio. That’s because most investors would be gradually investing money in the market. As they earn income, they save and invest. In other words, they’d be dollar-cost averaging into stocks. When we invest gradually over time, our portfolios turn profitable well before the overall market fully recovers. Consider my investing journey, for instance. I invested into a Schwab index fund for 10 years starting in 1996 and went through the big bad bear marketof early 2000s without flinching (mostly). You can see from the chart in this blog post how my investment had risen in value well ahead of the market reaching its previous high.
Others might be following a dry powder reserve approach like I do today (I use cash as dry powder). That would be another way to invest gradually.
So with all this data in our hands, what are the chances there will be a severe market decline in our near future? As media loves to harp on, it’s been nine long years since last major decline or an economic recession. Is it about to happen? Well, your guess would be as good as mine. To set the record straight, I don’t even try to hazard a guess given my lack of clairvoyance in such matters.
I am just hoping that the S&P 500 passes its previous peak soon so I could then sell some stocks and replenish my dry powder cash. If that happens, I’d be ready to pounce on the next 10% market decline with my dry powder reserve. Today, as things stand, if the market declines further from here without reaching its previous high first, I would then just have to wait for it to breach the 20% threshold before I am allowed to deploy more out of my dry powder reserves. (This is because I have already used up my 10% and 15% tranches.) I am not making bets either way but my portfolio would be ready for either outcome.