Five lessons we can learn from past market corrections

Crashes happen all the time, so how you react is key to the value of your portfolio

Crowds on Wall Street in New York, after the stock exchange crashed in 1929. History shows us that market crashes broadly follow the same pattern. Getty Images

This year’s stock market crash was one of the most dramatic on record, as the US S&P 500 index fell by 34 per cent between 20 February and March 23, an even speedier collapse than the financial crisis of 2008 or the Wall Street Crash of 1929.

Only the Black Monday crash of October 1987 was faster, when shares fell 31 per cent in just 14 days.

Markets seemed on course to top the 50 per cent falls seen in 1929 and 2008, but then governments and central bankers came to the rescue.

Last week, the S&P 500 closed at 2,874, a rise of 28 per cent from its March trough, as investors gambled that efforts to slow the virus would succeed, allowing the world to emerge from its self-imposed lockdown.

While the speed of the crash left investors shaken, and further aftershocks could follow, it is far from unprecedented.

A market meltdown is not a once-in-a-lifetime or a once-in-a-decade event, even if it feels like it amid the mayhem. History shows us they happen all the time, and broadly follow the same pattern.

If you are feeling anxious today, here are five lessons investors can learn from previous meltdowns.

A stock market crash is normal

Share prices crash. It’s what they do, and always will. Yet every time, it comes as a shock.

Most investors could name the big market meltdowns, notably the 1929 Wall Street crash, Black Monday in October 1987, the technology crash of March 2000 and the 2008 financial crisis, but these are only a fraction of the total.

Wikipedia lists an incredible 14 crashes in this millennium alone. Most are already forgotten, but they spread plenty of fear and panic at the time.

Do you remember the 2011 eurozone crisis, the China-driven meltdown in January 2016 or the sell-off in the three months to Christmas Eve 2018?

Probably not, even though markets fell by nearly 20 per cent every time, only to rally and embark on the next bull run.

Elie Irani, a member of SimplyFI.org, a non-profit community of UAE investment enthusiasts, says investors may think today’s crash is unprecedented, but they always feel that in a bear market. “The news looks bleak when you are in the eye of the storm, but history shows the market always recovers and continues its upward trajectory.”

Sitting tight is the best strategy

This is not the end of the world, so do not panic and do not sell unless you urgently need the money to pay a pressing bill.

Christopher Davies, a chartered financial planner at The Fry Group, says everyone needs to assess their tolerance for risk before they start investing. “Stock markets are among the most rewarding investments, returning on average 8 per cent a year since the 1950s, but you have to accept that they are volatile.”

Share prices fell by half in the 2008 financial crisis. “If you cannot stomach short-term fluctuations of this magnitude, then limit the amount you invest in equities,” Mr Davies says.

Stuart Ritchie, director of wealth advice at AES International, says investors need to look beyond short-term volatility, as markets have shrugged off natural disasters, referendums, questionable presidents and major conflicts. “In 1990, during the Gulf War, the S&P 500 dropped 16.9 per cent, but had recovered within six months,” he says.

It was the same after the 9/11 terrorist attacks in 2001, when Wall Street fell 11.6 per cent but was back to where it was before within a month.

Anybody who dumped shares during last month’s blistering sell-off may be kicking themselves, as markets have picked up over the past two weeks.

Mr Ritchie says in a bear market share prices can shoot up even faster than they fell. “If you had invested $10,000 in the S&P 500 40 years ago, you would now have $779,870. However, if you had been out of the market during the best five days, your returns would fall to $504,911. If you missed the best 50 days, you would have just $67,853,” he says.

Dramatic one-day climbs typically come during the initial recovery stage, following a crash. “You will miss out if you react by selling when markets are down, and buying back in when they are high,” Mr Ritchie says.

This is a great time to get greedy

If resisting the temptation to sell shares and funds is tricky, summoning up the courage to actively buy them is even harder.

History shows that a stock market crash like this one is a great buying opportunity, if you are bold enough to take it.

Black Monday in 1987 was the biggest one-day crash of all time, dwarfing anything seen in 1929, when stock markets in Asia, Europe and the US suffered falls of up to 23 per cent in 24 hours.

It took two years to recover those losses, and thereafter the S&P 500 grew by an average 14.7 per cent a year for the next five years.

Those who held on throughout the turbulence came out on top, but those who bought in the aftermath of the initial crash fared even better.

Mr Davies says history shows that buying at a discount in a bear market typically pays off, even if the market falls further. “Market recoveries are just as hard to predict as the initial correction. The best time to invest is when you have the funds to do so,” he says.

As always, make sure any decision you take to buy shares is in line with your attitude to risk, he adds.

The market may have rallied in the past fortnight but you have not missed your chance to buy bargain shares, as they are still about a quarter cheaper than at the start of the year.

Bear markets can last longer than you think

While it makes sense to feed money into today’s market, do not expect to become rich overnight, as the Covid-19 recovery period could prove slow.

The big question now is whether we will get a hugely desirable V-shaped recovery when the world is liberated from lockdown and goes on a spree, a less dramatic U-shaped recovery, a bumpy W-shaped recovery, or an L-shaped flatline.

Ayush Ansal, chief investment officer at Crimson Black Capital in London, says the sharp slump in global gross domestic product means the recovery is more likely to be L-shaped than V-shaped. “If we can emerge via a U-shaped recession, that will be considered a victory of sorts.”

Mr Ritchie says that whenever the market falls by 20 per cent or more it takes roughly536 days to recover.

Once again, this underlines the importance of investing for the long term, and being patient. You should never invest any money in the stock market that you are likely to need in the next five years.

Diversification helps

To avoid the full force of a bear market, it pays to have a diversified portfolio, holding bonds, cash, gold and property funds alongside shares.

Andrew Hallam, an offshore investment specialist and author of the Millionaire Expat, says bonds are "little angels" when stocks fall.

In the 2008 crash, a $10,000 portfolio made up entirely of shares would have plunged to only $5,978. “However, if you held 60 per cent stocks and 40 per cent bonds, it would have dropped to $7,494, which is easier on the nerves,” he says.

Mr Hallam says holding bonds helps you last the course as investors in more diversified portfolios “respond less foolishly” when stocks fall.

Mr Davies says gold also provides protection against sudden market swings. “The gold price is up around 35 per cent measured over the past 12 months, against a drop of 5 per cent on global shares, offsetting your losses,” he says.

While in some respects the Covid-19 crash is unprecedented, as we have no idea how the world will get out of lockdown, investors have been here before, and should heed the lessons of the past.