What Happens After the Stock Market Falls?

Buy low, sell high. Even if you know nothing about investing, you’ve heard this phrase before. With the S&P 500 20% off its highs, investors have an opportunity to execute on the first half of that statement.

As stocks decline, they become more dangerous in the short-run but more attractive over the long-run.

In order to show this, I made* a table below that shows the average returns over different time periods based on how far stocks are from their high. The data is from the S&P 500, price only, going back to 1950. Returns 1 year and over are annualized, so in order to show an apples-to-apples comparison, I left 3 month and 6 month returns white.

Once stocks fall 20%, long-term returns start to improve with every painful leg lower. This is why it’s so important to stay in the game. Nobody ever said you have to have all of your money in stocks, but you can’t be all cash either because lower returns today plant the seeds for higher returns tomorrow.

Base case numbers are important to look at, but not when it feels like the worst case is much more likely. I’ve got those numbers also.

The table below is the same as the one above only it’s showing the minimum returns going forward. Stocks can go a lot lower over the short-term, but over the long-term, the situation starts to improve dramatically.

Long-term returns have historically gotten more attractive as stocks decline, but over the following year, flip a coin. The chart below shows the 1-year  path of the S&P 500 following a 25% decline (we were down >25% on Thursday’s close).

There have been seven non-overlapping periods going back to 1950, and looking at the chart, it’s impossible to draw any conclusions. Three times it got worse, twice it got much worse. One time things got much better immediately, and three other times they got better but it took a while. In other words, be prepared for anything.

As I’m typing this, the Fed just fired their bazooka. They took rates back to zero and will be conducting a massive quantitative easing program. I think this was the right move, but at this point I’m much more worried about Main Street than Wall Street, and I hope fiscal stimulus is not far away.

Thank you for reading and stay safe everybody.

Thank you to Aron Pinson for the idea, and Nick Maggiulli for the data analysis

 

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