A History of Ups and Downs

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Our industry has a long and persistent habit of characterizing up and down markets as bull or bear markets, respectively. The origins of these terms in unclear, but they certainly connote what John Maynard Keynes referred to as animal spiritsinstincts, proclivities, and emotions that influence human behavior—in his book The General Theory of Employment, Interest and Money. The primary emotions in this case are optimism and pessimism about stock prices.

We prefer to characterize major market cycles simply as up and down markets and remove the emotion. In the chart on the previous two pages, we define an up market as a sustained rise in stock prices prior to a 20% decline and a down market as a sustained drop in prices prior to a 20% gain. There are a number of key observations from this data.

First, the period prior to America’s entry into World War II was marked by a series of shorter market cycles that had to be maddening for the relatively few wealthy investors and institutions involved in the stock market back then. After a 33% decline in stock prices that started in September 1929 and included the infamous “Black Tuesday” of October 29, the market recovered by 21% over just four months.

Those who believed that the 21% rise signaled a positive turn for their stock market fortunes were sorely disappointed as the market dropped a devastating 80% over the next two years. Then, in just two short months, the market almost doubled, up 92%! The market timers of the day must have been incredulous.

Fearing they would miss a substantial recovery, they no doubt jumped back in at some point, only to see their stock portfolios drop another 30% over the next six months. For those who had not jumped out of windows by then (yes, that happened), the market rewarded their perseverance with four years of rising prices, with stocks up a total of 283%. Then disaster struck again with a 50% decline over the next 13 months. When you throw in the next three cycles—up 65% in 18 months, down 26% in eight months, and up 21% in 15 months—it’s a wonder that anyone tried to time the market ever again.

By September 1941, the market was factoring in the enormous economic risk caused by the war in Europe, and stock prices began to fall once again. The Japanese attack on Pearl Harbor in December 1941 added greatly to the anxiety. But as America fired up its manufacturing base to support the war effort, the market recovered and rose substantially over the next four years. After a brief decline in the second half of 1946, the market enjoyed its biggest sustained up market in history, up 936% through December 1961. After a brief six-month decline, it continued up another 144% for more than six years.

So our second observation should be how much longer the up markets have lasted since 1941—almost three years. The down markets haven’t changed much, either in duration or degree. Books have been written on why this has occurred, but suffice it to say that better economic and monetary policies, broader participation in the markets, faster and more efficient flow of information, and certain regulations have helped. The U.S. also became the most powerful and most stable economic power on the globe after the war.

I’ll close with one more important observation. Look at the difference in duration of all the market cycles in the post-war period. Notwithstanding the degree of the drops, does it look like anyone in his or her right mind should try to time them? Consider the last major decline—from the market bottom in March 2009, stocks rose 26% in three months, 46% in seven months, and almost 66% in 14 months. That was followed by two months when they fell 13%. Over five consecutive months in 2011, stocks dropped over 16%! Yet those investors who stayed focused on the long run have enjoyed (in varying degrees) a stock market rise of 385% since the 2008-2009 debacle.

No one can predict when the next 20% decline (or worse) in stocks will occur. But one thing is certain: the high annual returns you see in the up cycles in Rick’s article are not sustainable forever. The 9%-10% expected return for the market includes these unpredictable down markets. Accepting that reality and working it into a sound, consistently applied, and focused long-term plan like Equius offers is really your best choice.

Please see the source of data and disclosures on the prior two pages.

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