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Equities: What goes down must come up April 2008
Most investors who are currently exposed to global equities are experiencing uncomfortable turbulence. On average the value of their investments, compared to a year ago, has dipped considerably. This is exacerbated by the fact that the experts disagree as to whether the worst is over or yet to come.
The novelty of the current economic crisis lies, not so much in the global credit squeeze, but rather in the lack of understanding of what the impact will be and over what period of time.
Regardless, however, of the vast amount of commentary and debate that the sub-prime crisis has generated, equity investors can be comforted by one major factor: historical trends.
An informative, and comforting, trend is that of equity revival soon after market deterioration.
Since August 1957 (and excluding the current economic crisis) there have been 11 market “meltdowns”. Within a year of each decline the market has shown marked recovery. Specifically, and with reference to the S&P 500:
Period
Total decline (%)
Total gain in year after decline (%)
Aug-Dec '57
-15
43.4
Jan-Oct '60
-8.4
32.6
Jan-Jun '62
-22.3
31.2
Feb-Sep '66
-15.6
30.6
Dec '68-June '70
-29.1
41.8
Jan '73-Sept '74
-42.7
38.2
Jan '77-Feb '78
-14.2
16.5
Dec '80-Jul '82
-17.2
59.5
Sept-Nov '87
-29.6
23.4
Jun-Oct '90
-14.7
33.5
Apr '00-Mar '03
-40.9
35.1
(Source: Compustat; Ibbotson & Sinqualfield “Stocks, bonds, Bills & Inflation”, University of Chicago Journal of business (Jan ’76; Standard & Poors, Alliance Bernstein)
This data is interesting for two reasons:
Firstly, as this trend was evident in all developed global markets, it shows a propensity for speedy recovery after economic crises, regardless of the period or intensity of the crisis.
Secondly, in 9 out of 11 situations, the percentage recovery in the year after the decline was greater than the percentage devaluation over the crisis period.
The next trend, which is an important adjunct to the above, is that equity values rise over the long term, regardless of the intermittent declines. Between 1950 and 2007 the S&P 500 experienced an annualized return of 11.7%.
The third relevant trend relates to market predictability. Generally the market moves in unpredictable intervals, and investors who enter and exit the market, rather than remaining in it, are more likely to miss the best trading days.
If, for example, you had invested $100 in 1981(S&P 500) and retained that investment until 1999, it would have been worth
$1, 082. If you missed the best 10 trading days over that period, your investment would be worth $417 less*
In summary, these historical trends indicate that:
• There is a real likelihood that the market will not only recover but will recover quickly and strongly
• In all probability, equities will continue to increase in value over the long term
• Equity Investors who choose to sit tight stand a better chance of realising greater gains in the medium to long term
Certainly this is no cure to the credit malaise, but this may be a sensible strategy to adopt in a time when investors are in danger of making irrational decisions.
