The Consequences of Fleeing the Market

Over the past three months, we’ve seen bad news followed by more bad news in markets around the world. U.S. stocks have lost over 10% and international stocks have lost over 25% year-to-date.

While the current downturn is worrisome, let’s take a look at what investors experienced during previous market downturns.

The chart shows various U.S. market downturns from 1960-2010 and the subsequent 12-month returns that immediately followed the downturn. The red bars show the downturns and the green bars show the recoveries immediately following the downturn.

There have been nine downturns that resulted in losses of more than 20%. The average downturn resulted in a loss of -35%. U.S. markets are already down -20% from this year’s high. So from this perspective the downturn this year while painful is not the worst we’ve experienced.

That brings me to some bad news: We may not necessarily have hit the bottom yet and might still have a while to go since the current losses are less than what we’ve experienced in the past. But as always, predictions are just guesses about the future. This time it could truly be different both in terms of having fewer losses or potentially having more losses than historical averages.

The average downturn lasted about 13 months before the recovery. Right now we’ve “only” experienced three months of losses. So not only has the depth of the current losses been less than average, the time period of this year’s downturn hasn’t equaled the average time period of previous downturns. In previous downturns you had to hang in there far longer than what you’ve done this year.

Not every downturn resulted in a recovery. For example, the losses from 2000-2001 was followed by another year of losses.

While none of that is encouraging, fleeing the market during the downturn can have some disastrous consequences for your portfolio. For instance, you can see that the subsequent recoveries were huge, with average gains of about 39% over a 12-month period.

Not only were the gains bigger in percentage terms, but they happened in a shorter amount of time than the downturns. In other words downturns tend to last longer than the rapid recoveries that follow.

The swift upturns can leave you far behind if you bailed out of the market during the downturn. Imagine a scenario where you sold stocks in the downturn and also missed the upturn. You just experienced the worst combination possible.

So while the current confluence of events has not happened before, realize that the current downturn is of a size that we’ve experienced before. And since no one can consistently time the market, the consequences of fleeing during these times can potentially leave you worse off than you would be if you stayed the course.