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Beware "Most of the Time"
09/14/2009 2:03 pm EST
You shouldn’t be worried that the recent 50% (and more) rally from the March lows will be followed by a vicious collapse. Since World War II, most of the time a year after a move of 30% or more in a six-month period, stocks were higher yet a year later.
In eight of the nine cases since World War II, according to the data that Floyd Norris ran in his September 12th column in The New York Times, the market was higher a year later. The best return after an initial six-month rally was the 26% gain in the six months after March 1986.
Most of the time—indeed, almost all of the time—you would have profited from holding for a year even after a huge move like the one stocks have made from the March 2009 low.
Most of the time.
That’s the most treacherous concept in investing. The one that’s the hardest to get your mind around in an organized fashion. The one that’s hardest to honestly factor into your investment decisions.
Because, of course, “most of the time” isn’t all of the time.
In the post-World War II period, holding on for a year after the October 1980 rally peaked would have produced a 10% loss.
And, if you go back further, holding for a year after the March 1937 peak in the Dow Jones Industrial Average would have produced a 36% loss. The preceding gain from April 29, 1936 (Quite a bit longer time period than the postwar examples, Norris cites, I readily admit, but a loss is still a loss) to March 10, 1937, had been 35%.
So, what do you do with “most of the time?”
You take some comfort that the odds are on your side. Eight out of nine is the kind of edge you should go for as an investor.
You figure that postwar 10% loss is certainly acceptable as a worst-case scenario given the odds on making a gain of 2% to 26% in the year after.
You don’t get carried away by the case of that 26% gain. Only three of the eight gains are in double digits. It’s more reasonable to expect the 8% of 1971 or the 7% of 1975 or the 5% of 1983 than that 26%.
Comparing the possibility of an 8% gain with the possibility of a 10% loss still leaves the odds on the side of sticking with stocks now. But this kind of gain doesn’t suggest that it’s time to take on huge risks.
And finally, by expanding the data series to include 1936 through 1938—even through the example isn’t exactly comparable—you learn something about the nature of the risk you’re facing now beyond the mere numerical odds.
What the 10% loss of 1980-81 and the 26% loss of 1937-38 have in common is the economy. In 1980, the economy, which had looked like it was on the road to recovery, instead went into a double-dip recession.
In 1937, the economy, which had managed to crawl out of the Great Depression, sank back into what is called by some the Roosevelt Depression because it was caused by the Roosevelt administration’s prematurely withdrawing the stimulus that had fueled the recovery to date.
I think that still leaves the odds on your side, even after this huge rally.
A double-dip recession is a real possibility now, but the 1980 double dip still produced only a 10% loss in a year after the peak.
It takes something like the 1937-38 slump to put a 37% loss on the historical record, so unless you’re predicting something like that, you’re not looking at a huge downside in a correction from this rally.
At least that’s what investors can expect most of the time.
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