Many people are concerned about investing their hard-earned money in the stock market.
It is well understood that market corrections can occur at any time, and the fear of market crashes can cause even the most experienced investors to second-guess their decisions.
While it is true that putting your money on the line is never easy, the stock market’s track record is undeniable.
Because of our unique ability to recognise patterns, humans have thrived throughout history.
For example, by figuring out how the seasons worked and realising that winter only came once a year, humans were able to successfully grow crops and thrive. We can repeat this pattern indefinitely, resulting in massive amounts of food and abundance.
Like the seasonal patterns, there are clear patterns in financial markets that can be seen across decades of data.
Today, we’ll look at some facts and patterns related to the stock market and market crashes.
Understanding these facts will allow us to prepare for the financial market’s recurring seasons, including the market crash, and will give you a significant advantage over experienced investors.
200 Years of Stock Performance in the United States
How has the stock market fared over the last 200 years?
We have the total annual returns of US equity returns over nearly 200 years using data from Slickcharts and the Journal of Financial Markets.
Returns are from the S&P 90, the S&P 500’s predecessor, from 1926 to 1956.
Finally, from 1957 to 2020, returns are calculated using the S&P 500.
The Standard and Poor’s 500, abbreviated as the S&P 500, is a stock market index that tracks the performance of 500 large companies listed on US stock exchanges. The S&P500 index is commonly used to represent the performance of the US stock market.
Historically, equity returns in the United States have been positive.
Here’s how the return distribution looks:
[Reference] https://advisor.visualcapitalist.com/historical-stock-market-returns/
Three years in a row, the market fell below 30%. They were in 1931 during the Great Depression, 1937 (The Roosevelt Recession), and 2008 (The Global Financial Crisis).
There were five years when the stock market increased by more than 50%. They were in the years 1862, 1879, 1885, 1933, and 1954.
Almost 40% of annual returns have fallen between -10% and 10%.
The average total annual return from 1825 to 2019 was 9.56%.
Over the same time period, more than 70% of total annual returns were positive.
[Reference] https://advisor.visualcapitalist.com/historical-stock-market-returns/
Despite multiple wars, the worst financial crisis since the Great Depression, the dot.com bubble, the oil crisis, and numerous other setbacks, the market is still up!
Bear markets become bull markets
“The best opportunities come in times of maximum pessimism,” said John Templeton.
Because the economy is cyclical, recessions are usually followed by strong recoveries.
When a bear market ends, the next 12 months can see significant market gains.
Despite temporary setbacks, the market has always risen.
The stock market lost nearly 11% in 1957, the year the S&P 500 was established. The following year, stock prices increased by more than 43%.
The global financial crisis of 2008 resulted in one of the largest equity losses in history. Stocks rose nearly 27% in 2009, boosted by expectations of increased capital spending and demand as the economy recovered.
Corrections occur once a year on average.
A correction is defined as a decrease of 10% or more but not more than 20%.
For more than a century, the market has experienced approximately one correction per year. In other words, corrections are a normal part of financial seasons, and you can expect to see as many corrections as birthdays in your lifetime.
The average correction looks something like this:
- 54 days long
- 13.5% market decline
- Occurs once per year
The uncertainty of a correction can cause people to make major errors, but most corrections are over before you know it.
The storm will most likely pass if you hold on tight.
Only about 20% of all corrections result in a bear market.
A bear market is defined as a prolonged period of price declines in a stock or market, typically of 20% or more from a recent high.
When the stock market begins to fall, it can be tempting to jump ship by selling assets and investing in cash. However, this could be a costly mistake.
You’d most likely be selling all of your assets at a low point, just before the market recovers!
Why? Because only about 20% of corrections result in bear markets.
In other words, 80% of corrections are just short breaks in bull markets, which means that if you sell too soon, you will miss the rest of the upward trend.
What about bear markets?
Bear markets have historically occurred every three to five years, but they do not last.
According to a First Trust Advisors analysis based on Bloomberg data,
[Reference]https://www.ftportfolios.com/Common/ContentFileLoader.aspx?ContentGUID=4ecfa978-d0bb-4924-92c8-628ff9bfe12d
There have been 14 bear markets in the 75 years between 1947 and 2022, ranging from one month to 1.7 years in length (on average they lasted about a year).
In the S&P 500, severity ranged from 20.6% to 51.9%.
The average Bull Market period, on the other hand, lasted 4.4 years, with a cumulative total return of 154.9%.
The bull market typically lasts longer and yields higher returns.
The Best Months to Invest in Stocks
Many investors believe that certain times of the year are better than others.
Is there any truth to these claims, or are they nonsense?
We can look into the data gathered by Schroders, a British asset management firm.
This study is based on 31 years of data from four major stock indexes:
- FTSE 100 (Footsie 100): An index of the top 100 companies on the London Stock Exchange (LSE)
- MSCI World: An index of over 1,000 large and mid-cap companies within developed markets
- S&P 500: An index of the 500 largest companies that trade on U.S. stock exchanges
- Eurostoxx 50: An index of the top 50 blue-chip stocks within the Eurozone region
Between 1987 and 2018, the data shows the historical frequency of these indexes rising in a given month as a percentage.
We will concentrate on a few outliers in the dataset.
[Reference] https://www.visualcapitalist.com/the-best-months-for-stock-market-gains/
December has historically been the best month to own stocks in terms of frequency of growth. Growth occurs 79% of the time. 19.9% greater than the mean
This corresponds to a phenomenon known as the “Santa Claus Rally,” which suggests that equity markets rally during the Christmas season.
According to one theory, the holiday season has a psychological impact on investors, causing them to buy rather than sell.
We can also assume that many institutional investors are taking time off during this period. This could give bullish retail investors more influence over the market’s direction.
The second best month was April, which is traditionally a good month for the stock market. The growth frequency is 74.3%. 15.2% greater than the mean
According to one theory, many investors receive tax refunds in April, which they then use to buy stocks. Prices rise as a result of the influx of cash.
The BAD Months to Invest....
According to this analysis, the three worst months to own stocks are June, August, and September. Is it a coincidence that they all take place in the summer?
One theory for the season’s relative weakness is that, like in December, institutional traders are on vacation.
However, the market is less frothy without the holiday cheer, and the reduced liquidity leads to increased risk.
Whether you believe it or not, the data does demonstrate a compelling pattern. As a result, the phrase “sell in May and go away” has gained currency.
But INertia always Trumps bad timing!
Do you know why we keep encouraging our students to take a long-term approach to stock investments?
Because the US stock market has never lost money in the last 20 years!
Markets in the United States have consistently outperformed over long holding periods, dating back to the nineteenth century.
The Measure of a Plan compiles a set of data that depicts the performance of the US market over various rolling time horizons using annualised returns.
[Reference] https://themeasureofaplan.com/us-stock-market-returns-1870s-to-present/
A 1-year view reveals a lot of red, indicating that the market was down for a considerable time.
Unfortunately, if you chose a one-year period at random, there is a good chance you will lose money.
Over 146 years of data, the probability of seeing negative returns in any given year is approximately 31%.
However, as the timeframes lengthen – to 5-year, 10-year, and then 20-year rolling periods – the frequency of losses decreases rapidly.
There hasn’t been a single instance of the market returning a negative return by the time you get to the 20-year windows.
Over a 20-year period, the US stock market has never lost money.
[Reference] https://themeasureofaplan.com/us-stock-market-returns-1870s-to-present/
If you invest in the stock market for 20 years, your maximum annualised return will be 13.2% and your minimum annualised return will be 0.5%.
Long-term investors can see that if your time horizon is measured in decades, your chances of making money in the stock market are as safe as putting money in the bank.
Warren Buffett put it best: “the stock market is a device for transferring money from the impatient to the patient”.
The most eye-opening study is one conducted by the Schwab Center for Financial Research (SCFR).
Assume you have $2000 to invest each year for the next 20 years, from 2001 to 2020.
[Reference] https://www.schwab.com/learn/story/does-market-timing-work
If you invested at the best time of year (with perfect timing), you’d have $151,391 at the end of the two decades.
If you bought Treasury Bills. You completely avoid the stock market. You’d end up with $44,438.
Here’s the kicker: How would you fare if you were the unluckiest person alive and invested at the worst time of year every year?
You’d end up with $121,171, which is far superior to cash and nearly as good as having perfect timing!
That is why Tony Robbins says, “The biggest danger isn’t a bear market correction, it’s being out of the market.”
James Lim
SFA Founder
Member of Australian Investors Association (AIA)
The University of Queensland Speaker
