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When do the markets hit bottom? What we can learn from previous market crashes?

The declines and volatility in the markets have been painful for anyone with a retirement plan or stock holdings and that means most adults in developed countries including Canada. What is on everyone’s mind right now is when do we hit bottom – how far will the declines go?

If you’ve been reading our publications long enough, you know we are not going to try to predict market timing. Our main point has always been that it is impossible to accurately time markets, especially for amateurs who don’t have increasingly sophisticated models of the economy and the markets. However, that doesn’t mean we can’t take some lessons from previous financial crises.

Before we begin, we need to give one HUGE caveat. We have not experienced a market sell-off or a recession triggered by a health event. All the previous market crashes have been triggered by economic events or cycles, such as the Financial Crisis in 2008. In this case, we are really going into uncharted territory and since the markets hate uncertainty, they’ve taken a beating. If we were to come up with an effective treatment or vaccine against the Corona Virus tomorrow and all the world’s economies started working again, we might be “back in business” with markets heading up toward pre-crash levels. But even though this is an unusual trigger, what happens during and after a crash is instructive.

Also, in this case we are going to look at US markets since most of the research has been done on them. We all know that the Canadian markets closely follow the US markets (not exactly, but close), so the learnings in the US market will be helpful for the Canadian market.

First, let’s remember (or explain for those too young to remember) the last 4 big market crashes not including this one.

Black Monday (1987)

On October 19, 1987, markets dropped more than 20% in a single day. The crash was thought to be caused by a computer-driven trading model but was exacerbated by the panic that was created as investors dumped their stocks.

In this case, the drop didn’t presage a recession and those who stayed calm and didn’t sell (or those who bought after the drop) did very well. The markets recovered in less than a year.

What can we learn?

I can’t give you too many person insights on this as I had no money invested at the time but avoiding panic selling was the major lesson everyone took away at the time (but of course that lesson didn’t stick and we keep having to relearn it over and over). Bust (End of 2000, 2001)

This one I remember well. For a long time, we all talked about the crazy valuations of the new Internet economy companies including that was reportedly funded at a crazy valuation based on the strength of the domain name. As early as 1999 we started to predict a crash that never came and we began to doubt fundamental economic principles.

When the crash finally happened at the end of 2000 and into 2001 we all had fallen into the trap of thinking that economic cycles had stopped and markets would go up forever. I believed that so much that I bought some Nortel stock after it had dropped 50% off its highs and when the market seemed to be turn back positive. I remember saying “how low could it go”? The answer was – zero. Nortel went bankrupt and I lost everything.

This greed-driven run up in the stock market evaporated almost as fast as it had grown, and it took many years for prices to go back to the levels seen at the height of the bubble.

What can we learn?

If something seems overvalued or doesn’t make sense, the market will find it, eventually. Plus, the markets always go down. In terms of today’s crash, there were many “false bottoms” in 2001 and 2001 and had you bought too soon, you found (as I did) that the markets had much further to fall. So be patient; the bottom lasts a while and you don’t need to find the absolute lowest point to make a good return on the way back up.

Financial Crisis (2008)

Most of us still remember this story and the story has even been told in Hollywood (The Big Short). Large financial institutions had become overexposed to packaged subprime loans. In other words, they made too many loans to people who should have never gotten loans. Plus, those same institutions bought packages of these bad loans as investments. They were rated as low risk because there were a large number put together (somehow the feeling was that a lot of garbage packaged together was something other than garbage). When some of the loans started to fail, the loan packages started to fail and then the financial institutions started to fail, starting with Lehman Brothers.

Despite efforts by governments to prevent a possible collapse of the world financial system, markets crashed and the Great Recession started. The Dow Jones fell 777.68 points on September 29, 2008 which until recently was the largest point drop in history. By March 5, 2009 the market dropped more than 50% to 6,494 from a high of 14,164 just a few months previously. By comparison, we had a 2997 point drop on March 16, 2020 and the markets have dropped 33% from almost 30,000 in February of 2020 to right around 20,000 today.

In 2008, the economy plunged into a long and deep recession with 8.8 million jobs lost in the US and employment going up to 10% by October 2009. Since the stock market reflects expectations about the FUTURE (not the present), the stock market crash preceded the long period with a weakeconomy.

In terms of the stock market, it took about 16 months from the peak of October 1, 2007 to the final bottom on February 1, 2009 for the market to stop declining and start increasing again. But again, note the two false bottoms in March 2008 and June 2008. You might have been tempted to get back in, only to see the bottom fall out again as the market continued to fall.

In terms of when to get back in the market, had you waited a couple of months after missing the real bottom on February 1, 2009, you would have lost the potential of a 14% gain (from February 1 to April 1). But that seems like a small price to pay to avoid a false bottom and, what looks like a clear bottom now in hindsight could have very well have been another false bottom at the time.

What can we learn?

All the previous lessons held in 2008

  • Avoid panic selling.

  • If the market seems overvalued it probably is although it might take time to adjust.

  • Markets always go down.

  • After a crash there are lots of false bottoms. Be patient.

  • While you’ll be eager to buy at the bottom, you don’t need to find the absolute bottom so be patient.

What should we do now?

So based on everything we just discussed, what should the ordinary investor do now? Before we go there, we need to remember the caveat we started with - this market crash is different than any other as it started with a health event. We really don’t know how badly the economy is going to be affected. And there is even a chance that the entire world will effectively shut down for months or years, which would be devastating to companies and to the markets that trade their shares. Markets could easily lose 50-75% of their value.

But with the warning made, let’s look at the market right now. The markets are 30% off their highs and it seems like a good time to buy back in. Are we at the bottom?

Unless it is part of your normal investing cycle (in which case you should proceed with your plan), be patient. Let things play out for another couple months so you don’t find yourself doing what I did and invest just before the bottom fell out of the market. If this is indeed the bottom and you miss it by a few months, your potential losses are a reasonable price to pay so that you don’t risk an even bigger downside. Remember that the markets lost 50% of their value in 2008 and we are only 30% down now. This situation has the potential to impact the global economy much more seriously than in 2008.

Hang in there and be patient.

#wealthmanagement #FinancialCrisis #StockMarket #investing #personalfinance #FinancialPlanning

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