In the past three weeks, the stock market has sent investors a severe warning: stocks may also fall.
Despite the benchmark S&P 500 (SNPINDEX: ^ GSPC)iconic Dow Jones Industrial Average (DJINDICES: ^ DJI)and growth oriented Nasdaq Compound (NASDAQINDEX: ^ IXIC) Revealing itself in the record recoveries of March 23, 2020, the bear market down, conditions are ready for a stock market crash.
Since emotion is the main driver of short-term price movements, we will never know precisely when a crash or correction is coming. But make no mistake, crashes and corrections are an inevitable part of the investment cycle, and some would say the price of admission to the greatest wealth creation tool on the planet.
With that in mind, here are six stock market crash metrics that every investor should keep in mind.
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1. A Shiller P / E greater than 30 leads to a bear market, historically
As noted, the market does not usually give us telltale signs that a crash is coming. One of the few indicators that, so far, has a very immaculate history of call crashes is the Shiller S&P 500 price / earnings (P / E) ratio. .
In the past 150 years, the average reading for Shiller P / E is 16.79. As of March 3, 2021, the Shiller P / E was at 34.59 – more than double the historical average.
This is where it gets interesting. There have only been five highs in the bull market in history, where the Shiller P / E for the S&P 500 surpassed 30 and held for a period of time. Some of these periods may ring a bell, such as the Great Depression, the dot-com bubble and the coronavirus crash. Admittedly, the March 2020 crash had nothing to do with assessments and was purely a response to a pandemic that occurs once in a generation. However, this does not change the fact that the previous four instances of the Shiller P / E exceeding 30 led to declines in the S&P 500 ranging between 20% and 89%.
In other words, history suggests that when the Shiller P / E reaches above 30, a fall or a bearish market soon follows.
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2. Corrections occur every 1.87 years
No matter what kind of decline awaits investors in the future, it is important to recognize how common these downward movements in the stock market are.
According to data from market research firm Yardeni Research, there have been 38 declines of at least 10% in the widely followed S&P 500 since the early 1950s. Over that 71-year period, we are talking about a double-digit decline every 1.87 years on average.
Remember that averages are just that – averages. There were long periods when corrections were few and far between. For example, there was not a single double-digit fault or correction between 1991 and 1996. In comparison, there have been seven percentage double-digit drops in the past 11 years, with at least eight other drops ranging from 5.8% to 9.9% .
Corrections are a healthy and normal occurrence.
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3. The average correction is six months
While corrections tend to discourage optimists, here is some good news: most crashes and corrections do not last long.
Dating from 1950, 24 of the 38 double digit percentage corrections of the S&P 500 reached their lower limit in 104 days or less (about 3.5 months). It took another seven between 157 and 288 calendar days to reach its limit. This means that only seven significant declines in the market have lasted more than a year in the past seven decades.
When we add these values together, the S&P 500 has spent 7,168 days in correction since 1950. This results in an average duration of correction of 188 days, or just over six months. Compare this figure to the 11-year bull market we just left and you can see why it is worth being an optimist.
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4. The corrections of the modern era are a month shorter, on average
Leave the song “but wait – there’s more”.
Although fixes and crashes have been relatively short-lived in the past 71 years, they are even shorter in the modern era. I am defining “modern era” as the emergence of computers, which have helped immensely in negotiations and in providing a balance between supply and demand for stocks. I am using 1985 arbitrarily as the beginning of this modern era.
Since 1985, the S&P 500 has suffered 16 double-digit declines. This includes the dot-com bubble, which at 929 calendar days is the longest drop in the history of the benchmark. Even with this outlier, the average duration of a failure or correction in the modern era is only 155 days. This is an entire month less than the historical average for the broad-based index.
With the Internet giving retail investors instant access to information, the barriers that existed between Wall Street and Main Street have been broken down. This played a key role in reducing the duration of corrections and failures.
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5. 70% of the worst market days are followed by your best earnings
Another interesting statistic that is sure to raise an eyebrow or two is the correlation between the best and worst days of the stock market. While some people may be tempted to run for cover at the first sign of trouble, history shows that this is the worst possible thing.
Last year, JP Morgan Asset Management released what has become an annual report that examines the continued 20-year returns of the S&P 500. In particular, JP Morgan Asset Management looked at how different investor returns would be if they lost just one handful of market returns better days over a 20-year period. Between January 3, 2000 and December 31, 2019, losing only the top 20 days would have effectively eliminated an average annual return of 6%.
But what really draws attention is the proximity between the best and worst days of the S&P 500. According to the report “Impact of being out of the market”, from January 3, 2000 to April 19, 2020, “Seven of the ten worst days were followed on the NEXT DAY [emphasis by J.P. Morgan Asset Management] for the first 10 returns over the 20 years or for the top 10 returns in their respective years. ”
If you try to trick the market, you are the one who is played.
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6. Long-term investors are hitting 1,000
I saved the best stock market crash metrics for last.
A rise in the market ended up placing each of those 38 drops in the rearview mirror. And in many cases, it only took weeks or months to clear the falls. For practical purposes, it doesn’t matter when you buy during a correction or failure. As long as you buy shares in a variety of innovative, high-quality companies and hold those shares for long periods, you have an exceptionally good chance of making money.
If you need more evidence, Crestmont Research data on the S&P 500 shows that at no time between 1919 and 2019 the index’s 20-year returns were negative. In fact, only the final two years of that 101-year period generated average annual total returns (that is, including dividends) of less than 5%. If you buy with the intention of keeping it for a long time, the historical data suggests that you will do very well.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even our own – helps all of us to think critically about investing and making decisions that help us become smarter, happier and wealthier.