I love history.
Finance, military, Greek…all of it.
Last night I was listening about life during the time of Martin Luther. Not the more recent ‘I have a dream…’ Martin Luther King Junior, the 15th century priest who was responsible for many of the breakaway sects of Catholicism.
He translated the bible from Latin to German, and told the people to interpret scripture for themselves, as they see fit.
That seems harmless today, but back in Luther’s day it was radical stuff.
I think what I like most about history is what you can learn. How does that old adage go? Those who do not learn from the past are doomed to repeat it.
So what can history teach you about this recent stock market correction?
Bulls versus bears
Throughout history, bull markets (when stocks are going up) have lasted far longer than bear markets (when stocks are going down).
Since the 1930s, bull runs on average last for about eight years, while bear markets only last for 18 months.
Does that mean you should jump out after an eight year run?
Of course not!
The past rarely repeats itself. That’s why in finance we say: history doesn’t repeat itself, but it often rhymes.
I have no idea how long the next bull or bear market will last. But I’m confident that future bull runs will last far longer than bear markets.
This is really what it’s all about — learning from the past to make better decisions in the present.
Knowing how a future bear market could play out will help you when faced with a similar situation.
For one, you probably won’t sell out when the market panics, because you know bear markets are over pretty quickly.
And right now, it seems all investors could use a bit more confidence.
Friday last week, we again followed US stocks down. ‘Correction’ is the word on everyone’s lips.
If this lasts much longer we could be heading into a full-fledged bear market.
According to Ray Dalio, founder of the world’s largest hedge fund, ‘…these big declines are just minor corrections in the scope of things.’ He went on to say, ‘…there is a lot of cash on the side to buy on the break, and what comes next will be most important.’
If this is the start of a much longer decline, why not learn from the past to see what we could be in for?
Let’s take a quick trip back in time…
Two crashes, seven corrections
You are your own worst enemy.
Investing is not hard. You already know what to buy — high returning stocks for bargain prices.
What gets in the way of buying these great investments is you.
When the market falls, you feel an urge to jump out. When it rallies higher, you want in.
I’m not trying to pick on you. We all have these feelings.
What separates the good investors from a great one is not information, superior models or any of that stuff. It’s the ability to ward off innate feelings we all have.
Warren Buffett sums it up as being fearful when others are greedy and greedy when others are fearful.
That means you jump in as the market crashes, and sell out at new highs.
Right now it’s a time to be greedy. Easier said than done, right?
So let’s take a look at past declines to see what we’re in for.
First let’s take a look at some of the biggest declines our market has ever had.
First up is 1987.
In October, the Dow Jones dropped more than 30%. The All Ordinaries (the 500 largest Aussie stocks) followed, dropping 48%.
It took us 21 weeks from the top to reach the bottom. Had you bought before the drop, you would’ve waited eight and a half years to see any kind of positive returns.
The only other time we’ve crashed as hard was in October 2007.
The all Ords dropped 54% from its high of 6,760.1 points.
It took 73 weeks from top to bottom. And we still haven’t seen the index come anywhere near that 2007 high.
Now let’s take a look at a whole bunch of corrections we’ve had along the way.
Take a look at the table below.
[Click to enlarge]
Since 1988, we’ve seen an average decline of 13.2% during a correction. It took around 2.3 years to reach a bottom and another 2.2 years to rebound past the previous high.
Will the same happen in 2018?
Setting yourself up to profit
The point of studying past corrections is to build your confidence. As you can see, the average correction was a fall of 13.2%. And it took a little over two years to recover.
Of course there are outliers like 2007. And 2018 could possibly be one of those outliers.
We’ve never seen interest rates this low for so long before. We’ve also got more money in passive investments like exchange traded funds than ever before.
There are a lot of variables today that didn’t exist in the past. But that shouldn’t stop you from setting up investments to profit if our market heads back up.
Editor, Money Morning
PS: Correction? Vern Gowdie, our award winning financial planner, has long believed we’re in for a full blown crash. You can check out his research here to read why, and how you could insulate yourself from the fallout if he’s right.