Economics and markets

How to react when markets drop

March 14, 2022

Downturns aren’t rare events: Typical investors, in all markets, will endure many of them during their lifetime.
Bear markets and corrections are a part of life for investors, who are best served by maintaining a long-term focus.   Since 1980, global stocks have endured nine bear markets, defined as a market decline of 20% or more lasting at least two months. Despite these downturns, global stock prices have continued to new heights, showing the value of staying invested even during periods of subpar performance.  It’s worth noting that the downturn that began in March 2020 at the start of the COVID-19 pandemic doesn’t meet our definition of a bear market because it lasted less than two months. We have included it in our analysis because of the magnitude of the decline.
Dramatic market losses can sting, but it’s important to keep a long-term perspective and stay invested in order to participate in the recoveries that typically follow­.
While bear markets can be daunting for investors, on average they have been much shorter than bull markets and have had far less of an effect on long-term performance.  From January 1, 1980, through December 31, 2021, the average length of a bull market has been nearly four times that of a bear market. The depth of losses from a bear market has paled in comparison with the magnitude of bull-market gains.  That’s one reason for sticking to a well-thought-out investment plan. Losses from a bear market have typically given way to longer and stronger gains.  It’s worth noting that the downturn that began in March 2020 at the start of the COVID-19 pandemic doesn’t meet our definition of a bear market because it lasted less than two months. We have included it in our analysis because of the magnitude of the decline.
Timing the market is futile: The best and worst trading days often happen close together and occur irrespective of the overall market performance for the year.
Investors shouldn’t try to time the market because they run the risk of missing out on some of the best-performing trading days.  Historically, the best and worst trading days have tended to cluster in brief time periods, often during periods of heightened uncertainty and distress, making the prospect of successful market-timing improbable.  As this chart shows, the best and worst trading days often occur within days of each other. From January 1, 1980, through December 31, 2021, nine of the 20 best trading days as measured by the Standard & Poor’s 500 Index occurred during years of negative total returns. Meanwhile, 11 of the 20 worst trading days occurred in years with positive total returns.
As the random pattern of returns below highlights, predicting which segments of the markets will do well is also a tough order.
This chart displays the relative annual performance of major sub-asset classes from 2014 through 2021, as well as the relative monthly performance of these sub-asset classes during the fourth quarter of 2021. The chart shows that relative performance among sub-asset classes varies widely from year to year and month to month with leaders and laggards changing frequently.   Sub-asset classes include large-cap equity as measured by the S&P 500 Index, small-cap equity as measured by the Russell 2000 Index, developed ex-U.S. equity as measured by the FTSE Developed ex-North America Index, emerging markets equity as measured by the FTSE Emerging Markets Index, U.S. fixed income as measured by the Bloomberg U.S. Aggregate Bond Index, global ex-U.S. fixed income as measured by the Bloomberg Global Aggregate ex-U.S. Bond Index, high yield fixed income as measured by the Bloomberg Global High Yield Bond Index, and real estate as measured by the FTSE EPRA/NAREIT Developed REIT Index.
Riding out the rough periods can pay off. That includes rebalancing into asset classes even when they are declining instead of pulling out of the market.
This chart shows the performance of a hypothetical example 60% stock/40% bond portfolio during and after a sharp market downturn. It stood at $1 million on the morning of November 1, 2018, and lost 5.7% of its value by Christmas Eve. Yet selling the portfolio at that time and fleeing the markets, even if briefly, would have cost investors tens of thousands of dollars in two months, versus the alternative of staying invested. Investors who stayed invested would have had a portfolio of $1,042,046 on February 28, 2019. Those who went to cash on Christmas Eve but reinvested on January 2, 2019, would have a portfolio of $1,009,820 on February 28, 2019. Investors who went to cash on Christmas Eve and stayed in cash would have a portfolio of $973,362 on February 28, 2019. And those who went to cash a few days earlier when the portfolio reached its Christmas Eve low would have a portfolio of only $943,529 on February 28, 2019.
What you can do when volatility hits:
Bear markets and corrections are a part of life for investors, who are best served by maintaining a long-term focus.   Since 1980, global stocks have endured nine bear markets, defined as a market decline of 20% or more lasting at least two months. Despite these downturns, global stock prices have continued to new heights, showing the value of staying invested even during periods of subpar performance.  It’s worth noting that the downturn that began in March 2020 at the start of the COVID-19 pandemic doesn’t meet our definition of a bear market because it lasted less than two months. We have included it in our analysis because of the magnitude of the decline.
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