You shouldn’t be worried that the recent 50% (and more) rally from the March lows will be followed by a vicious collapse. Since World War II, most of the time a year after a move of 30% or more in a six month period, stocks were higher yet a year later.
In eight of the nine cases since World War II, according to the data that Floyd Norris ran in his Saturday September 12 column in the New York Times, the market was higher a year later. The best return after an initial six-month rally was the 26% gain in the six months after March 1986.
Most of the time, indeed almost all of the time, you would have profited from holding for a year even after a huge move like the one stocks have made from the March 2009 low.
Most of the time.
That’s the most treacherous concept in investing. The one that’s the hardest to get your mind around in an organized fashion. The one that’s hardest to honestly factor into your investment decisions.
Because, of course, “most of the time” isn’t all of the time.
In the post World War II period holding on for a year after the October 1980 rally peaked would have produced a 10% loss.
And, if you go back farther, holding for a year after the March 1937 peak in the Dow Jones Industrial Average would have produced a 36% loss. The preceding gain from April 29 1936 (a quite a bit longer time than the post War examples, Norris cites, I readily admit but a loss is still a loss) to March 10 1937 had been 35%.
So what do you do with the “most of the time?”
You take some comfort that the odds are on your side. Eight out of nine is the kind of edge you should go for as an investor.
You figure that post-War 10% loss is certainly acceptable as a worst-case scenario given the odds on making a gain of 2% to 26% in the year after.
You don’t get carried away by the case of that 26% gain. Only three of the eight gains are in double digits. It’s more reasonable to expect the 8% or 1971 or the 7% of 1975 or the 5% of 1983 than that 26%.
Comparing the possibility of an 8% gain with the possibility of a 10% loss still leaves the odds on the side of sticking with stocks now. But this kind of gain doesn’t suggest that it’s time to take on huge risks.
And finally, by expanding the data series to include 1936 through 1938—even through example isn’t exactly comparable, you learn something about the nature of the risk you’re facing now beyond the mere numerical odds.
The thing the 10% loss of 1980-81 and the 26% loss of 1937-38 have in common is the economy. In 1980 the economy, which had looked like it was on the road to recovery, instead went into a double dip recession.
In 1937 the economy, which had managed to crawl out of the Great Depression, sank back into what is called by some the Roosevelt Depression because it was caused by the Roosevelt administration prematurely withdrawing the stimulus that had fueled the recovery to date.
I think that still leaves the odds are your side, even after this huge rally.
A double dip recession is a real possibility now but the 1980 double dip still produced only a 10% loss in a year after the peak.
It takes something like the 1937-38 slump to put a 37% loss on the historical record so unless you’re predicting something like that you’re not looking at a huge downside in a correction from this rally.
At least that’s what investors can expect most of the time.