Published on April 2, 2020 in the Rochester Business Journal
If there’s one thing the month of March 2020 has taught us, it’s that the stock market doesn’t go
up in a straight line. Indeed, since its very inception, the equity market has experienced
corrections, bear markets (often associated with recessions), and crashes. These events occur
irregularly, but with some frequency, and, accordingly, it’s important to understand the
differences between them, what causes them, how long they last, and what typically follows each
unique set of circumstances.
Market corrections are generally categorized by a pullback of 10% or more from a recent high.
They can be caused by any number of events, but usually occur when reality fails to live up to
one or more short-term expectations. It could be that Gross Domestic Product (GDP) came in
weaker than expected for one quarter, that changes to fiscal or monetary policy didn’t go far
enough to appease investors on a short-term basis, or that corporate earnings were lower than
expected, causing stock prices to fall, as a mechanism for discounting slower growth. On
average, these corrections occur every 8 to 12 months, and tend to last anywhere from 2 to 5
months. Afterward, equity markets typically resume their upward trajectory, unless something
more serious comes along to cause a bear market or, even worse, a crash.
Bear markets usually refer to a 20% or more drop in stock prices and tend to be brought on by
more problematic trends in the market, including a global political shock, significantly lower
disposable income, weaker productivity, plummeting consumer confidence, rising default rates,
or some other series of events that begin to instill fear in the market. When these situations arise,
some investors begin to sell investments, in an effort to escape future losses. This can amplify
the so-called “fear trade,” leading to higher volatility and worsening general market conditions.
History teaches us this type of market timing – the “get me out now, get me back in later
strategy” – isn’t effective over extended periods of time, but let’s put that argument aside for
now. The fact is bear markets have occurred approximately once every seven years or so since
1920 and, according to CFRA (Center for Financial Research and Analysis), have lasted an
average of 14 months since World War II, and an average of 22 months since 1926. Following
each bear market, equities tend to experience a significant recovery, in the form of bull markets
that have generated cumulative returns of between 48% and 417% over a multi-year period.
Crashes are usually described as an extreme bear market, where fear leads to panic, and panic
leads to a significant decline over a very short period of time. Since the early 1900s, the stock
market has really only “crashed” twice – once beginning in October 1929 (overconfidence,
margin debt, and a steep increase in interest rates, ultimately leading to a short-term run on the
banks), and again in October 1987 (disconnect between equity markets and derivative securities,
lack of liquidity, anti-takeover legislation, etc.). We’ve certainly experienced other significant
bear markets, such as those beginning in March 1937 (premature spending cuts during the Great
Depression), January 1973 (price controls and the Arab oil embargo), March 2000 (bursting of
the tech bubble) and October 2007 (financial crisis, leading to the Great Recession) but, in these
instances, markets fell sharply over a much longer period of time. Most bear markets and
recessions/crashes last for less than 20 months, and all have been followed by significant bull
market runs.
As of Friday, March 27, the S&P 500 Index was down 25% from its 52-week high, and the Dow
Jones Industrial Average was down by nearly 27%, mostly due to the fear and panic caused by
the coronavirus, a price war in oil being waged by Saudi Arabia, Russia and others, and the
economic fallout the combination of these events will undoubtedly have on corporate earnings
and society at large. Given the circumstances, and as amplified by today’s algorithmic trading
platforms that buy and sell stocks automatically if a particular index rises or falls to a specific
level, things may, in fact, get worse before they get better. The speed at which markets have
fallen over the past few weeks is unprecedented and is already being referred to as a crash.
Remember, though, it’s always darkest before the dawn, and this, too, shall pass.
During times like these, it’s imperative that investors don’t succumb to the fear and panic that
have overtaken so many. Act rationally, stay invested, and work with your advisor to use recent
market events to your best advantage. Since the early 1900s and on an annual basis, the market
has gone up approximately 73% of the time, and the ups have generally been much larger than
the downs – this is what keeps us invested. Accept that corrections, recessions and crashes are a
normal part of being an investor. Remember that the market goes up and down, but always with
an upward bias. Keep your cool, maintain a long-term focus, and don’t try to time the market.
Your patience will ultimately be rewarded, just as it has so many other times in the past.
To see his column in the RBJ, click here.
This material is provided for general information purposes only. Investments and insurance products are not FDIC insured, not bank deposits, not obligations of, or guaranteed by Canandaigua National Bank & Trust or any of its affiliates. Investments are subject to investment risks, including possible loss of principal amount invested. Past performance is not indicative of future investment results. Before making any investment decision, please consult your legal, tax or financial advisor. Investments and services may be offered through affiliate companies.