Lessons from market declines
The types of market declines, plus lessons learned from past corrections.
Stock market corrections are an inevitable part of investing. They’re also the last thing most investors want to experience.
Types of stock market declines
One of the problems in dealing with a decline is that you don’t know at first whether it’s just a slight dip or a longer, more serious correction. A look back at stock market history* since 1900 shows declines have varied widely in intensity, length and frequency.
The study below shows how frequently declines in the Dow Jones Industrial AverageSM have occurred since 1900. As you can see, they have been regular events.
A history of declines (1900–December 2007)
| Type of decline | Average frequency | Average length* | Last occurrence |
|---|---|---|---|
|
Routine
(–5% or more)
|
About 3 times a year | 47 days | November 2007 |
|
Moderate
(–10% or more)
|
About once a year | 113 days | November 2007 |
|
Severe
(–15% or more)
|
About once every 2 years | 216 days | October 2002 |
|
Bear Market
(–20% or more)
|
About once every 3-1/2 years | 332 days | October 2002 |
Past results are not predictive of results in future periods.
Source: the unmanaged Dow Jones Industrial Average. Assumes 50% recovery rate of lost value.
* Measures market high to market low.
Lessons from market declines
What lessons can we take from past market declines?
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No one can predict consistently when market declines will happen.
It’s easy to look back today and say with hindsight that the stock market was overvalued at a particular time and due for a decline. But no one has been able to accurately predict market declines on a consistent basis. In January 1973, a New York TimesSM poll of eight market authorities predicted that the market would “move somewhat higher” in the future. The Dow industrials proceeded to decline 45% over the next 23 months. Then, although almost no one predicted it, the Dow rose 38% in 1975.
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Since 1982, with few exceptions, market declines have been brief and, for the long-term investor, relatively painless. A longer look at history shows that long-term investors have come out ahead but that the pain has often been substantial.
After the 1929 crash, it took investors 16 years to restore their investments if they invested at the market high. But after the 1987 crash, it took 23 months to get back. In 1990, it took only eight months, while after the 2000 decline, it took about five years to recover. All cases assume dividends were reinvested.
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Successful market timing during a decline is extremely difficult because it requires two near-perfect actions — getting out at the right time and getting back in at the right time.
Getting out of a bear market is easy — all you have to do is sell. A common mistake investors make is to lose patience and sell at or near the bottom of a downturn. But even if you have decent timing and get out early in a decline, you still have to figure out when to get back in. A bear market is not usually characterized by a straight-line decline in stock prices. Instead, the market’s downward trend is likely to be jagged — showing bursts of stock price increases, known as “sucker’s rallies,” and then declines.
Living with a market decline isn’t easy, but if you understand these lessons, you’ll be a more intelligent investor.
Note: Be sure to discuss these issues with your financial professional before making any changes to your financial plan.