History Shows Stock Gains Can Add Up After Big Declines
Sudden market downturns can be unsettling. When they come in the context of a war in Europe, inflation not seen in 40 years, a lingering global pandemic, and the reverberations of a violently contested presidential election, it’s understandable if one’s nerves are a bit raw right now.
And yet, what we are seeing from markets in May of 2022 is both normal and expected. History has taught us that we can’t know the precise timing or magnitude of bear markets. History has also taught us that patience is a virtue. The stock market’s ups and downs are unpredictable, but history supports an expectation of positive returns over the long term. For the best shot at the benefits the market can offer, investors need to stay the course.
Stock returns, as we are currently experiencing, are volatile. But nearly a century of bull and bear markets shows that the good times have outshined the bad times. As depicted below, from 1926 through 2021, the S&P 500 Index experienced 17 bear markets (defined as a fall of at least 20% from a previous peak) [1]. The declines ranged from –21% to –80% across an average length of 10 months. On the upside, there were 18 bull markets (defined as gains of at least 20% from a previous trough). They averaged 55 months in length, and advances ranged from 21% to 936%. When the bull and bear markets are viewed together, it’s clear equities have rewarded disciplined investors.
Exhibit 1: S&P 500 Index Total Returns
Source: Dimensional Fund Advisors
And, historically, US equity returns following sharp downturns have, on average, been positive.
Since 1926, broad market index tracking data in the US (broader than the S&P 500) shows that stocks have tended to deliver positive returns over one-year, three-year, and five-year periods following steep declines [2].
Cumulative returns show this to striking effect. Five years after market declines of 10%, 20%, and 30%, the cumulative returns all top 50%.
Exhibit 2: Fama/French Total US Market Research Index Returns
Source: Dimensional Fund Advisors
Sticking with your plan helps put you in the best position to capture the recovery.
Finally, it can be helpful to remember that today, this week, this month, are all just a moment in time that does not condemn the current year as a lost cause. Stock market slides over a few days or months may lead investors to anticipate a down year. But a broad US market index had positive returns in 17 of the past 20 calendar years, despite some notable dips in many of those years [3]. Even in 2020, when there were sharp market declines associated with the COVID-19 pandemic, US stocks ended the year with gains of 21%.
Exhibit 3: Market Volatility
Source: Dimensional Fund Advisors
Volatility is a normal part of investing. Tumbles may be scary, but they shouldn’t be surprising. A long-term focus can help investors keep perspective.
Disclosures
[1] Exhibit 1: In USD. Chart end date is December 31, 2021; the last trough to peak return of 119% represents the return through December 2021. Due to availability of data, monthly returns are used January 1926 through December 1989; daily returns are used January 1990 through present. Periods in which cumulative return from peak is –20% or lower and a recovery of 20% from trough has not yet occurred are considered Bear markets. Bull markets are subsequent rises following the bear market trough through the next recovery of at least 20%. The chart shows bear markets and bull markets, the number of months they lasted and the associated cumulative performance for each market period. Results for different time periods could differ from the results shown. A logarithmic scale is a nonlinear scale in which the numbers shown are a set distance along the axis and the increments are a power, or logarithm, of a base number. This allows data over a wide range of values to be displayed in a condensed way. Source: S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
[2] Exhibit 2: The average annualized returns for the five-year period after 10% declines were 9.54%; after 20% declines, 9.66%; and after 30% declines, 7.18%. Past performance is no guarantee of future results. Short-term performance results should be considered in connection with longer-term performance results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Market declines or downturns are defined as periods in which the cumulative return from a peak is –10%, –20%, or –30% or lower. Returns are calculated for the 1-, 3-, and 5-year look-ahead periods beginning the day after the respective downturn thresholds of –10%, –20%, or –30% are exceeded. The bar chart shows the average returns for the 1-, 3-, and 5-year periods following the 10%, 20%, and 30% thresholds. For the 10% threshold, there are 29 observations for 1-year look-ahead, 28 observations for 3-year look-ahead, and 27 observations for 5-year look-ahead. For the 20% threshold, there are 15 observations for 1-year look-ahead, 14 observations for 3-year look-ahead, and 13 observations for 5-year look-ahead. For the 30% threshold, there are 7 observations for 1-year look-ahead, 6 observations for 3-year look-ahead, and 6 observations for 5-year look-ahead. Peak is a new all-time high prior to a downturn. Data provided by Fama/French and available at mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. FAMA/FRENCH TOTAL US MARKET RESEARCH INDEX 1926—present: Fama/French Total US Market Research Factor and One-Month US Treasury Bills. Source: Ken French website. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful.
[3] Exhibit 3: January 2002–December 2021, in US dollars. Data is calculated off rounded daily returns. US Market is represented by the Russell 3000 Index. Largest Intra-Year Decline refers to the largest market decrease from peak to trough during the year. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful.
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