Historical Market Downturns: What We Can Learn From Them Now

The Coronavirus is taking a huge toll on human life and on the economy, forcing stocks into a bear market (a drop of at least 20 percent lasting on average 1.4 years) and generally associated with an economic recession. Panic, while not helpful, is certainly understandable under these circumstances. While no one can know what the future will bring, we can study previous market downturns to put our fears into a historical context. After all, panic is not a strategy! 

At Linscomb & Williams, we help clients, especially right now, remain focused on their long-term goals. At times like these, stress can lead investors to make emotional decisions, and this can lead to some crucial mistakes. (Read our recent blog post: When the World Feels Like It’s Falling Apart – Big Mistakes to Avoid.) 

While there’s no “specialized expertise” that can ever help you predict the future, you can learn from history. In our nearly 50 years of experience in the financial services industry, we’ve seen many different market situations. The lessons learned from the 8 major bear markets in the last 100 years may help you temper your reactions and maintain the long-term view of your investments.

 

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1. September 1929 to June 1932 (-83.4%)

The term “bear market” often brings to mind the biggest bear market in Wall Street’s history – the Stock Market Crash of 1929, which ushered in the Great Depression. This included Black Tuesday (Oct. 29, 1929), when stocks fell 12 percent and marked the end of the Roaring ’20s. In the years after World War I, companies posted record profits while margin requirements were only 10 percent, encouraging excess speculation in the markets. The resulting bubble caused the market to triple until it was burst by margin calls, disrupted growth and bankruptcies. 

After the end of the Great Depression, stocks climbed 815 percent in a 14-year period.

2. June 1946 to November 1946 (-21.4%)

The downturn in 1946 was caused by post-war inflation that resulted from pent-up demand. Regulators responded by increasing stock margins to 100 percent, which eliminated leverage on stock purchases. This forced many investors to sell stocks in order to comply with the new margin rules, sending the market into a short-term swoon.

The market continued to trade sideways through 1949, before entering a prolonged expansion in the 1950s. Stocks returned a handsome average annual return of 16.8 percent in the 15 years following the end of this bear market. 

3. January 1962 to October 1962 (-21.7%)

In essence, stocks became overpriced in the 1960s, as measured by Price to Earnings (P/E) ratios. Uncertainty was high due to political pressures centering around America’s dealings with Vietnam and Cuba. President Kennedy was pressuring the steel industry to temper higher prices, a move that upset business leaders.

When the bear market ended, investors who stayed in the market profited with an average annual return of 14.9 percent over the next 6.4 years.

4. November 1968 to May 1970 (-29.3%)

The second bear market in the 1960s was prefaced by high inflation and social unrest that included riots and assassinations. The economy was sluggish as the Vietnam War intensified, draining confidence from stock investors. 

The market then experienced a sharp rally in which prices increased 75.6 percent for the following 2-½ years. Market volatility was extremely high during this period.

5. January 1973 to October 1974 (-42.6%)

The great bull market of the early 1970s collapsed in 1973 and led to a 1.7-year bruising bear. GDP growth fell to -2.1 percent while inflation rose to 12.3 percent, creating the so-called “stagflation” economy. Oil prices skyrocketed during the first oil embargo, while the Watergate investigation took its toll on investor confidence. Nixon’s resignation came a few months before the end of this bear market.

The subsequent bull market saw stocks rally 845 percent for the next 13 years.

6. August 1987 to December 1987 (-29.6%)

The late 1980s brings up another infamous bear market, one that featured the infamous Black Monday decline of 23 percent on Oct. 19, 1987, triggered by a confluence of global events and technical programmed trading strategies in the equity market. Stock prices were high (market P/E ratio of 20), inflation was on the rise and a strong dollar was damaging exports. The Black Monday panic was exacerbated by computer-based trading that was then in its infancy and lacked today’s circuit breaker mechanisms.

For those who held onto their stocks, the next almost 13 years rewarded them with a total return of 845.2 percent.

7. March 2000 to October 2002 (44.7%)

The Y2K period culminated with the dot-com panic that resulted from the overhype of Internet companies. Speculation was high in the wake of a balanced budget, lower capital gains tax rates and the anticipation around the so-called “peace dividend.” High-tech companies had high P/E ratios and there was much talk about “vaporware.” This bear market was prolonged by the 9/11 attacks and the demise of Enron. 

The market started to recover in late 2002, and then doubled in value through 2007. 

8. October 2007 to March 2009 (-50.9%)

At the turn of the century, a five-year rally continued until late 2007 with the start of the Great Recession, triggered by a collapse of the mortgage-backed derivatives market. The underlying cause was deteriorating mortgage loan standards, which resulted in defaults and foreclosures. Once investors started questioning the high credit ratings assigned with these standards, it led to insolvencies and bankruptcies. Asset values fell and economies went into recession worldwide.

This Brings Us to Today

The bull market that followed the Great Recession lasted 11 years, making it the longest bull market in history, returning 339 percent. This all ended last month, when the Coronavirus pandemic triggered the current bear market, with a decline that started following February 19, 2020.

Lessons Learned

So, what have we learned from all this? 

The most obvious lesson is that we periodically have bear markets – no one has rescinded the business and market cycles. The average length of bear markets is 1.4 years (and actually shorter if you leave out the Great Depression of the late 1920s), much shorter than the average bull market length of 4-½ years. The result? Stocks go down in a bear market faster than they go up in bull market. 

History also teaches us that bear markets end, and over time, stocks go up. 

When you are caught in a bear market, the most common impulse is to convert your stocks to cash. This is an appealing idea if you could accurately predict the bottom of the bear market. Unfortunately, this ability is exceedingly rare. There is no “specialized expertise” that helps someone predict the future. We wish we could make such a call with accuracy but now with experience that we cannot. 

Given that the future is unpredictable, the only way to protect your assets over the long run is to stay focused on your long-term goals – bull market or bear. One of the worst things you can do is lock in your bear market losses and then miss out on the next bull market.

There are opportunities to reduce your overall risks by diversifying your investments across a wide range of assets. In that way, some assets may zig while others zag. The more types of assets you own, the less your overall risk. Your asset allocation should reflect your appetite for risk and typically change as you age. However, when you are near or in retirement, you also have to consider inflation and how you keep up with increasing prices. It can be dangerous to try to hide too much from one type of risk and discover that you are backing right into a different flavor of risk. 

Financial planning can be complicated and complex, especially during bear markets, and in a bull market, when prices are high, it’s easy to think investing is easy! Working with a financial advisor you trust can help keep you focused on your long-term plans and provide the peace of mind many investors are seeking.

Bottom line: You don’t need to panic during a bear market. Instead, position yourself so you can benefit when the market turns up again.

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Ryan L. Patterson, CFA, CFP®

Ryan L. Patterson, CFA, CFP®

Ryan Patterson is Linscomb & Williams' Chief Investment Officer.

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