I hope you’re sitting down, folks, because I have some news that could be upsetting to some of you: A stock market crash or steep correction may be coming.
With the coronavirus crash — a 34% decline registered in the benchmark S&P 500 (SNPINDEX: ^GSPC) over just 33 calendar days during the first quarter of 2020 — still fresh in the minds of many investors, the last thing you probably want to think about is a repeat performance. Yet, history tells us that’s likely where we’re headed. But as you’ll soon see, crashes and steep corrections aren’t necessarily events to fear.
A crash or steep correction may be closer than you realize
If there’s one historic figure that sticks out like a sore thumb, it’s the S&P 500’s Shiller price-to-earnings (P/E) ratio. The Shiller P/E looks at inflation-adjusted earnings over the previous 10 years. Looking back 151 years, the average Shiller P/E for the S&P 500 is 16.82. On May 20, it closed at 36.88.
However, more than doubling the historic average Shiller P/E ratio isn’t what’s worrisome. Rather, it’s what’s subsequently happened the previous four times this ratio has crossed above and sustained 30. In those instances, the S&P 500 lost anywhere from 20% to 89% of its value. The latter, which occurred during the Great Depression, is extremely unlikely today, thanks in part to the Federal Reserve using monetary policy to stabilize financial markets. Nevertheless, the key takeaway is that when valuations get stretched, a 20% pullback is the minimum expectation. And this isn’t all.
History also tells us that rallies from a bear-market bottom are never without hiccups. Over the past 61 years, there have been nine bear markets, including the coronavirus crash. In looking at the previous eight bear markets, each and every one underwent at least one or two double-digit percentage declines in the three years after a bottom was reached.
History isn’t the only concern, either. The prospect of rapidly rising inflation, spreading coronavirus variants, and over-leveraged investors (i.e., those relying on margin), could all potentially torpedo what’s been a historic bounce-back rally.
The odds are always in your favor (if you’re a long-term investor)
But, as promised, there is good news. That’s because I can offer 38 very good reasons why you don’t ever have to fear a stock market crash or correction.
According to data provided by market analytics company Yardeni Research, there have been 38 official corrections in the S&P 500 since Jan. 1, 1950. By official, I mean declines of at least 10%. This works out to a double-digit decline, on average, every 1.87 years. But it’s not the frequency of these declines that’s impressive. It’s that each and every one of these big moves lower was eventually erased by a bull-market rally (38-for-38). In a number of instances, it took mere weeks or months to put a crash or correction in the rearview mirror.
Want more evidence? Financial market analysis company Crestmont Research released a report earlier this year that examined the 20-year rolling total returns (i.e., including dividends) for the S&P 500 between 1919 and 2020. This meant analyzing the average annual total return for all 102 years between 1919 and 2020. The result? Not a single end year for the previous 102 years would have resulted in a negative average total annual return over 20 years. In fact, only two of the 102 years (1948 and 1949) produced average total returns below 5%. Meanwhile, more than 40 of the end years resulted in average annual total returns of at least 10%.
If you trust your investment theses, buy significant dips in the stock market when they arise, and stay the course over the long run, the data says you’re going to make money.
Conservative and aggressive investors can both make bank
Maybe the best part about staying the course is that it benefits conservative investors just as much as those willing to take on more risk.
For example, a lot of investors use the S&P 500 as the benchmark index they’d like to beat. What they might not realize is that the S&P 500 has averaged about an 11.2% total return since the beginning of 1980. Put another way, conservative investors who purchased an S&P 500 tracking index have been taking less than seven years to double their money, assuming their dividend payouts are being reinvested. There’s no shame whatsoever in these returns, which are handily outpacing inflation.
Likewise, investors who’ve stayed the course with game-changing businesses have been handsomely rewarded. For example, e-commerce giant Amazon (NASDAQ: AMZN) has had three instances where it’s declined more than 50% from its high, and one instance where it lost more than 90% of its value (between 2000 and 2002). Since 2010, it’s had five instances where it’s undergone at least a 20% haircut. And yet, despite these wild swings, growth investors who’ve stayed the course have made bank. That’s because companies like Amazon, which controls 40% of all U.S. online sales and has a leading cloud infrastructure segment (Amazon Web Services), don’t grow on trees.
As long as you have a long-term mindset and allow your investing thesis to play out, the data is crystal clear that you have a very good shot to build wealth on Wall Street following each and every crash or correction.
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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Sean Williams owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.