Market Returns 5 Years After Historical Market Declines
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The only investment “given” that I know for certain is that markets go up and down. I suspect that anyone out there can argue with that. Whether you look at it from a short-term day by day perspective or a long-term 50 year time horizon the market has been proven time and time again to do just that. Most likely the stock market is going to continue doing this in the future.
So what does that mean considering we are in what many are calling a very historic stock market correction based on some real fundamental problems in the system? The following chart may help shed some light on what may happen in the future. Thanks to EmergDoc on the Bogleheards forum for the link to this graph:
Click to Enlarge
As you can see, every time the market had real bad year, the returns the following five years were pretty good. I am not saying this is going to happen again, however the only thing we as investors really have is the past to draw inferences from. And if things go as they have in the past, then there is the potential for some pretty strong gains in the next 5 years.
However, not to be swayed by just one point of reference, I did some Googling to see what others have found when analyzing stock market returns following market crashes. This article at SeekingAlpha provides some more details. The message here is that the market eventually recovers, it can just take some time.
For an individual who is in the accumulation phase as I am, I am continuing to invest in equities to the maximum extent that I can (subject to my asset allocation of course) and will hopefully be able to enjoy this potential gain, if and when it comes. The way I see it, it is really all I can do. I am not going to put my money under the mattress and would rather take the risk and wait for history to repeat itself.
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ObliviousInvestor said:
Hi TDG, thanks for bringing this point up. It’s one I’ve been thinking about a lot lately as well.
The periods-high-returns-after-periods-of-low-returns isn’t really a fluke. There’s very good reasoning behind it.
It’s simply that, by the end of a period of low returns, the average market P/E ratio is generally quite low–generally far below a historically typical P/E ratio.
Therefore it’s very likely that at any point some years later–whether that’s 5 years, 10 years, or 20–the average market P/E ratio will be higher (even if we assume that the P/E ratio at any point is random and entirely unpredictable). And the increase in P/E ratio–plus the normal effect of dividends and earnings growth–will lead to somewhat above average returns.
April 6th, 2009 at 6:00 am
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