Here on the Best Interest, I provide a lot of “you should be investing!” advice. I talk about the power of long-term investments. And stock market strategies. And even about my specific investment choices. But today is different. Today’s post is about the upcoming market crash. Well…it’s coming eventually.
Perhaps you’ve come to believe that I’m an unwavering bull. A pure optimist. That I think investments can do nothing but increase in value. But that’s not true. I know the crash will come. It always does.
And that might seem scary. If the crash is coming, then why not do something about it? So that’s what today’s post is about. Even though we’re aware that a market crash is coming (eventually), we can take a step back and think about it rationally.
Being a Bull Before the Market Crash
Here’s a prediction.
I predict that I will eventually make a blog post where I say something like,
“I bought some shares of an index fund this month—just like every other month. And I think it’s one of the smartest things you can do as an investor.”
And after that future blog post, the market will proceed to fall 30% over the next few months.
Some people will then look at the Best Interest and think, “Pfff! This guy Jesse doesn’t have a clue what he’s talking about! He invested a few thousand bucks right before the market crashed!! What a dummy!”
I’m calling it now. It’ll happen. And I understand why it will appear like I’d be a dummy.
So let’s dig in. Am I a dummy?
Historical Data: The Market Crash Always Comes
The market crash always comes eventually.
Bear markets—where the stock market value drops by 20% or more from its previous high—have occurred 12 times since 1929.
|Years of Bear Markets||Percent Drawdown from Previous High|
|1929 – late 30s (Great Depression)||-86%|
|1956 – 57||-22%|
|1961 – 62 (Flash Crash of ’62)||-28%|
|1968 – 70||-36%|
|1973 – 78 (Bretton Woods + Oil Crisis)||-48%|
|1980 – 82||-27%|
|1987 – 88 (Black Monday)||-34%|
|2001 – 05 (Dot Com Bubble)||-49%|
|2008 – 09 (Financial Crisis)||-56%|
The market ebbs and flows, oscillating between “unsustainable optimism and unjustified pessimism.” If we believe the assumption that stock prices are current unsustainably optimistic, then it’s believable that a serious bear market could happen in the next few years.
But lesser corrections—typically defined as at least a 10% drawdown—occur even more frequently. Since 1950, there have been 37 corrections of 10% or more. That’s more frequent than one every two years.
It doesn’t take Nostradamus to predict a future market downswing. I’m not calling a 1-in-1000 event. Market corrections happen all the time.
“But if he gets elected…!!!”
You can find arguments from both sides of the political aisle that certain parties lead to better stock market performance. But let’s investigate the data itself.
First, let’s look at the president only. But heed warning: this is a slightly dangerous game. Does the president alone have enough influence to affect the stock market? Will the answers we find here be conclusive of causation? Or will they only present correlation?
From 1926 to 2020, we have 95 years of S&P 500 data. During that time, we’ve had 48 years of Democratic leadership and 47 years of Republican leadership. Republican years saw an average S&P 500 return of 9.0%, while Democratic years saw an average return of 14.9%.
That’s a pretty big difference! But is it causal i.e. one thing causes the other to occur? Can a system as complicated as the stock market be tied down to a single influencing variable like the president’s political party? Probably not.
After all, that’s only 23 presidential terms and 15 individual presidents. Eight Republicans and seven Democrats. Not exactly a huge sample set.
Keep this in mind for the next time a President tweet-brags about the stock market’s success.
President + Congress
But there is another working theory worth inspecting. The theory is that our government is more efficient when the Congress (both Houses) is controlled by the President’s party. If the President and Congress work together effectively, then we all benefit. It’s a “teamwork makes the dream work” situation.
In the 95-year period since 1926, we’ve had 48 years of President/Congress unification (14 years Republican and 34 years Democrat) and 47 years of division (33 with a Republican president and 14 with a Democrat). The market performance during these periods is very interesting.
|President / Congress||S&P 500 Average Annual Return|
|Dem / Dem (34 years)||14.5%|
|Repub / Repub (14 years)||13.9%|
|Dem / Repub or Split (14 years)||15.9%|
|Repub / Dem or Split (33 years)||7.0%|
|Total Unified (48 years)||14.3%|
|Total Divided (47 years)||9.7%|
Is this causal? Does a unified Federal government ensure that the economy and stock market perform better? I doubt it’s conclusive. But it is interesting nonetheless.
The market trends upwards no matter who is in office, but it appears that political cooperation might help grease the wheels.
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The Silver Lining of Market Crashes
Back when we consulted Mr. Market, one big takeaway was:
The only two prices that ever matter are the price when you buy and the price when you sell.
Ask yourself: what are your investing plans are for the next few years? Are you going to be a buyer—someone who is investing for the future? Or are you going to be a seller—someone who has invested for the past few decades and now wants to live off those investments?
If you’re a buyer, then a market crash has a pretty significant silver lining. Cheaper prices! If the market declines, then you get to invest at lower prices. It’s the easiest way to increase your long-term investing potential. Buy low, sell high. Dollar-cost average investors relish these chances to decrease their cost basis.
If you’re a seller, let’s look at how your past 30 years have been. The S&P 500 value was around ~350 in 1990. And now it’s at ~3500, or about 10x higher. If the market drops 20% next week to 2800, then your returns are only ~8x compared to 1990. But an 8x return ain’t bad!
“If the market crash is coming…why not sell now and wait to re-invest after the prices drop?”
Before I answer the question above, let’s consult Peter Lynch—who is considered one of the most successful investors of all-time.
Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves.Peter Lynch
What exactly is Lynch saying? How do people lose money by “preparing” for corrections?
People lose money “preparing” for corrections because they sell too soon and then don’t know when to buy back in. It’s that simple. Both actions—selling too soon and not buying back in soon enough—can cause investors to miss out of years of growth and years of dividends.
That’s why Peter Lynch’s quote rings so true. Timing the market is hard.
So we don’t sell in preparation for a crash. But what about saving up cash and waiting to buy? Why not hold cash, wait for the 10% drop (that we know happens every 2 years, or so) and buy in then?
Well, I looked at that too. Back in March ’20, my “Viral Stock Market Strategies” article (get it? viral?!) looked at an assortment of supposed strategies that involved holding onto cash while waiting for the market to drop. I back-tested these strategies against the historical S&P 500 data, and simple dollar-cost averaging beats all the “wait for a drop” strategies.
You think there’s a market crash coming? I know, me too (eventually). There’s certainly a chance that holding onto cash and waiting for the crash is correct right now. But if you try that tactic over time, it’s a losing strategy.
Don’t sell. And don’t wait to buy. Carry on with your normal investing cadence.
Don’t do something. Just sit there.Jack Bogle
“But what if it’s the crash?!”
What if what’s coming is the big market crash? The mother-of-all-crashes! What if society falls apart? Or if a meteor hits Earth and life changes as we know it? What if we all start scavenging for beans and scrap metal and fuel for our souped-up dirt bikes?
Scary questions, but they have a pretty simple answer. If an existential threat ruins your investments, then the stock market will be the least of your worries. That’s it. If “the big one” hits, then the stock market will be one of many societal structures that no longer matter.
If it’s not “the big one,” then the market will recover. It always does.
Why? Why does the market always bounce back? In part, it’s because humans are resilient. We learn and grow and work towards progress. While this year’s COVID market recovery can be attributed to many different factors—like the Federal Reserve lowering interest rates—it can also be attributed to human resiliency.
If “the big one” is coming, then shouldn’t you just “YOLO” and spend your money now? Yeah, you should. I suppose we all need to do some probability analysis.
- What are the odds that “the big one” is about to come and you look stupid that your investments become worthless?
- What are the odds that “the big one” never comes and you wish that you had invested in your younger years to enable retirement?
I’ll take my chances and save for retirement.
So, am I a dummy? I hope I’ve convinced you otherwise.
Even though we know that the stock market will eventually succumb to 10%, 20%, or even larger drawdowns, there’s no basis that you’ll benefit by trying to wait or time that market crash. It might work, but it usually doesn’t. That’s what the historical data tell us.
Waiting for the election doesn’t matter either. Democrats, Republicans…the market does its own thing. There might be some causality, but it’s tough to tell.
There are silver linings in corrections and crashes. If you’re investing for the long-term, then corrections enable cheaper prices and greater returns.
And if this market crash is “the big one,” then none of this really matters. It’s hard to blog if the electrical grid fails.
P.S. – If you enjoy podcasts, check out the Best Interest Podcast!