Stock Market Sell-Offs Without a Recession

The stock market is a forward-looking indicator. Markets are meant to discount future cash flows and events to a present value. It’s not always right — stocks have predicted four out of the last eight recessions and so on —  but investors are constantly looking for signals in stock prices to shape their current outlook.

In a swift drop like we’ve seen in the recent drawdown, it’s easy for many investors to confuse the stock market and the economy. This latest episode has many on recession watch. And it makes sense that people would think this way considering how long this current economic cycle has lasted.

Most of the largest crashes in stocks have coincided with a recession — 1929-32, 1937-38, 1973-74, 2000-2002 and 2007-2009 come to mind. Many of the level-headed, intelligent people I follow don’t seem to believe we’ll see a recession this year. They could be wrong and so could I, but we don’t generally go into a recession until excesses have built up in the system. It’s the old adage that you can’t kill yourself jumping off of a two-foot ledge.

Having said that, even if we don’t go into a recession that doesn’t mean the stock market can’t or won’t see a significant sell-off. Double-digit losses and even bear markets can certainly occur without a big economic downturn. This scenario has played out many times throughout history, as you can see from the following data:

Screen Shot 2016-01-15 at 3.35.27 PM

This has happened roughly one out of every five years since the late-1930s. If this does turn out to be one of these non-recessionary down markets then we’re more than half way through the average loss scenario (with the standard caveat that markets are never average in real time).

While losses in the stock market are never enjoyable they’re still the best chance most of us have to see large gains in the future. This is the paradox of investing that is so painful and counterintuitive for people to grasp. Lower prices mean higher yields and higher expected future returns when new cash is put to work.

Here are those same losses but this time I have added the subsequent 5 and 10-year total returns. (And because no one can really nail the bottom perfectly, I even showed the gains starting at the beginning of the following year, thus making these numbers fairly conservative.):

Screen Shot 2016-01-15 at 3.36.18 PM

I realize that visualizing future gains isn’t very helpful in the midst of a market sell-off. Psychologically and emotionally, losing money is difficult to stomach. Our brains are hard-wired to find losses more painful that gains are pleasurable.

Investors have become conditioned to assume that every stock market sell-off lines up perfectly with a financial crisis. While you can never completely rule out a full-blown panic because of investor emotions, reflexivity or an unexpected event, we don’t have to experience a 2008-level crisis every time there’s a correction or bear market.

Further Reading:
How Stocks Perform Before, During & After a Recession

 

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. Varun Sahay commented on Jan 18

    Right, this time around the China growth story is emerging and that has been a growing constant for the last 20 year. Now that China is decelerating and oil is falling at the same time the equation has changed and the results unknown. America is growing with no real wage growth, the unemployment numbers are skewed as they do not take the non working, on the bench into account. The sell off is justified that I dont know but is this rigged that I am guessing yes! How can a stock market have asymmetrical information when the Saudis are controlling the price of oil? Are they buying up US companies and preparing them selves for a new future without dependence on oil? The US should stop all Saudi funds from investing in US companies then the markets would have asymmetrical information.

  2. Scott commented on Jan 18

    re: “It’s the old adage that you can’t kill yourself jumping off of a two foot ledge.”

    But you can drown with a tablespoon of water…

    So many different ways to get yourself into trouble!

    • Ben commented on Jan 18

      that’s valid. just because something is rare doesn’t mean it’s out of the realm of possibilities

  3. Steve commented on Jan 18

    You may want to clarify that the negative numbers shown in your chart are not for the year

  4. Terri Edwards Nerium commented on Jan 20

    Is your brain drained or draining? Easy to understand. Signum Labs brought help and I endorse EHT. Learn more eterriedwards.buyneriumeht.com

  5. larryqpc commented on Jan 20

    Ben, could you clarify what the negative numbers in the first chart actually represent. Are they a single day highest negative during the listed year, or something else? Thanks.

    • Ben commented on Jan 20

      Those are the peak to trough drawdowns, so highest point to lowest in those given time frames. So those losses could have come after gains had already been seen.

  6. edinvestor1 commented on Jan 21

    “It’s the old adage that you can’t kill yourself jumping off of a two foot ledge.” Unless it is on the edge of bumper to bumper high speed road! ;-0