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Stingy Investor Tip Sheet
|Sell, Sell, Sell!|
Ok, I admit it. I occasionally have the villainous desire to go on TV
during a market panic and shout "Sell, Sell, Sell!" I could then rant
about how the markets are particularly dangerous. I'd end the tirade
with a less manic, "because I want to buy cheap stocks."
But after talking with investors over the last week, my days of
villainy are over. I'd feel badly for anyone who listened to the
'sell now' part of my speech and failed to notice the 'because I want
to buy' part.
Indeed, I'm a little reluctant to even post this quick look at the
history of stock market declines in the United States. I'm not really
interested in inspiring panic. But I do want to take a look at what
history has to say about the downside risk for stocks.
To focus on the downside, I start with the monthly S&P500 data
collected by Robert Shiller. I then calculate how much the S&P500
price index has fallen from its prior peak. You can see the results
in the accompanying graph which shows the downside faced by index
investors over various periods.
[click to enlarge]
In most cases, bear markets for the S&P500 were painful but relatively
quick. They may have lasted for, say, a few years. The granddaddy of
declines, the 1929 crash, was a different beast and it sent the market
down for decades.
But the figures presented do not include dividends. That's not a big
deal when the crashes are short lived but dividends do matter for the
1929 crash. Indeed, they decreased the time needed for the S&P500 to
recovery by many years. Nonetheless, I think the graph provides a
visceral sense of the historical downside risk for the S&P500.
If the past is a guide, index investors should expect 40% declines to
be relatively common. The big decline of 1929 shows that 'once in a
century' events can really hurt. Even worse, we don't know if
1929-style events actually occur only once in a century. Maybe they
tend to occur once every 200 years? Maybe they occur more frequently
and we've just gotten lucky? There is also no saying that a 90%
decline is the worst that can happen for stocks.
On the brighter side, stock markets do tend to recover given
sufficient time. The same can not be said for bonds but that's a
topic for another day.
|09/22/2008 3:00 PM EST Permlink save & share||Markets|