The stock market’s decline this year has already been painful. The key questions for many people are how excruciating it will ultimately become and how they can endure it.
The numbers aren’t pretty. Through Thursday the S&P 500 was down 15.4 percent from its Jan. 3 peak, and last Friday it briefly fell below the 20 percent threshold that defines a bear market on Wall Street.
But stocks have risen this week, for the first time in two months. It is certainly conceivable, though I think unlikely, that the worst of the damage is over and that the downturn of 2022 was just a flirtation with a bear market — a short affair that was never consummated. That has happened before, and fairly recently, at that.
Do you even remember the market’s pivot during Christmas week in 2018? It had been falling for months as trade tensions between the United States and China mounted. That Dec. 24, the S&P 500 closed 19.8 percent down from its peak, leaving it just a smidgen above the 20 percent bear market line. On the day after Christmas, it dropped briefly into bear market territory, only to rally smartly by the end of the day, said Howard Silverblatt, senior index analyst for S&P Dow Jones Indices. The market went on to gain more than 44 percent until its next big stumble early in the Covid-19 pandemic in February 2020.
Will this year’s market turn out to be another shy bear, one that has barely shown its face only to disappear for months? Or will it return as a ferocious beast that will punish investors who do not protect themselves from harm?
Alas, I don’t know the answer to that one, though I find it hard to accept the idea that this year’s cascading stock market declines are over. There seem to be too many negatives weighing on the markets, among them the Federal Reserve’s decision to tighten interest rates in response to soaring inflation, the continuing ravages of the coronavirus, the high price of oil and gasoline, and the war in Ukraine. Still, predicting where the market will head is a fool’s errand.
The best we can do is make educated guesses based on history and prevailing conditions.
As an investor, I hope the market rises immediately. But I’m preparing for further declines, buying stocks and bonds regardless. I’ve been doing this for decades. Tons of academic research suggests that it is fruitless to try to outsmart the market, so I use diversified low-cost index funds that track the entire stock and bond universe in the expectation of long-term gains.
This approach makes sense for people with long horizons, but the earlier you need the money, the more difficult your choices will be. Plenty of people have written to say they are grappling with these issues. Keep the questions coming. I’ll answer as best I can.
Watch and wait, or jump right in?
Because the stock market often falls, I wouldn’t invest a cent in it if I needed to spend it soon. Pay the bills first. I’ve suggested several alternatives for stashing your cash.
They include U.S. government I bonds, which now yield 9.62 percent, a rate that is reset every six months. Other short-term Treasury bonds and high-quality corporate bonds are reasonable choices, and bank accounts are safe, even if the interest they pay is minuscule.
Many readers say they have enough to live on, with money left over. Still, they wonder, should they invest in stocks when the market is so unsettled?
Bailey Wharton of Waimea, Hawaii, wrote to say he has spare cash to put into stocks and can afford to leave the money in the market for a long time. “Does it matter when to invest?” he asked. “Do I wait until it hits bottom and starts to recover or just bite the bullet and invest it now?”
On the phone, I said that unfortunately, I wouldn’t know that the market had hit bottom until it was too late to matter. If you are investing in broad index funds, and don’t need to worry about owning the wrong individual stocks at the wrong time, basic logic suggests buying stocks immediately rather than waiting.
But doing so assumes three important things: You have a long time horizon; believe that the market will act in the future more or less as it has done in the past; and can stomach severe downturns.
Remember that the U.S. market has risen over all periods of 20 years or more but has often declined over shorter stretches — and, sometimes, over long periods as well. Dollar-cost averaging, a fancy way of describing investing gradually and regularly, as many of us do through workplace retirement accounts, may mitigate the pain of making one big investment and watching it decline.
Mr. Bailey said he might take that approach, investing a set sum every month, so that he felt better if the market went into a protracted decline. “It might feel like I’m getting some bargains that way,” he said.
Are these prices really bargains?
Brian deWit of Memphis said he had been through major market declines before and viewed them as opportunities.
In a note, he wrote: “Don’t you just love a sale!?”
We chatted about whether stocks were really on sale. Yes, prices are much cheaper compared with several months ago. In that sense they are bargains, I said. But based on standard long-term metrics — comparisons of share prices to corporate earnings or to the value of the assets owned by companies — stocks still aren’t all that cheap.
More important as an investor is what stocks will be worth in one year, or three years or five or 20 or more. Since we don’t know the answer, the issue, really, is how long you can afford to wait. Mr. deWit said he had time — and, if need be, would pass his assets on to his daughter. “Eventually, the market will come back,” he said.
Lacey Volk of Pittsburgh had a similar question. She puts money into index funds regularly. “I’ve continued to invest the same amount during this downturn, and I just check my balance less frequently,” she wrote. “I’m in it for the long term so not too worried. Is it accurate to think ‘stocks are on sale right now’?”
In our conversation, she explained that she graduated from college in 2006 and that during the devastating bear market that began in October 2007, she lost much of the money that her parents had put away for her in a mutual fund. The U.S. stock market didn’t fully recover its losses until March 2012, according to a comprehensive database developed at the University of Chicago, known as CRSP (pronounced “crisp”), for the Center for Research in Security Prices.
Ms. Volk said she had sold her holdings at a loss before the market turned around, and “didn’t fully understand what was going on back then.” That experience led her to adopt a buy-and-hold approach, she said, but she wondered whether she could rely on it.
What has happened in the past?
Some statistics on the historical behavior of the stock market are worth considering. Dimensional Fund Advisors, an asset management firm, computed them, using the CRSP U.S. Total Market Index.
The data covered stock market returns from July 1926 through April 2022.
Some good news, first.
During that long period, the annualized returns for stocks was 9.95 percent. The cumulative return was a staggering figure that you may want to read slowly: 885,084 percent. (Low-cost index funds didn’t exist at the start of that period, so it was not possible to approximate those market returns, as it is now.)
The sobering news is that the market had 15 separate episodes in which stocks fell at least 20 percent.
On average, these were the findings from those bear markets:
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Total loss from market peak: 34.8 percent.
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Duration of the decline until the market bottom: 264 trading days.
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Time required to recoup those losses after the bottom: 567 trading days.
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Cumulative returns five years after a 20 percent decline: 69.9 percent.
Remember, those are average figures. It has sometimes been much worse than that. The most difficult period for investors in the last century was the Great Depression.
From Sept. 3, 1929, until the market bottom in June 1932, stocks fell 84 percent, and the market did not fully recover until Jan. 2, 1945.
The Great Depression won’t recur, because history doesn’t duplicate itself, but I think we can be confident that some very bad episodes undoubtedly are part of the future.
What should investors make of this history?
Ms. Volk said she found it unsettling but also, in a way, comforting. “I’m going to stick with it,” she said. “I’ve got some time. I think this is the way to go.”
In an email, John Morrison, senior investment strategist and vice president of Dimensional, suggested interpreting the numbers this way: “Understand the range of outcomes, but anchor expectations to the average,” he said. “Expecting an extreme outcome isn’t rational, and trying to predict the future is futile. Investors should embrace uncertainty and plan for what might happen instead of trying to predict what will happen.”
I agree with this perspective, with the caveat that those with limited time and resources will want to be extremely cautious about dabbling in the stock market. In another column, I’ll focus on prudent options for people who can’t, or won’t, risk riding out the declines that are part of pure stock market investing.
The start of 2022 has already given us a reminder of how painful a down market can be. And the numbers from the last 100 years demonstrate how lucrative stock market investing can be, and how difficult it can be to stay the course.
I hope the stock market won’t torment investors much more this year, but it would be wise to be ready if it does.
