It was a year of financial chaos, but what comes next?
Last year was the third-worst ever for the U.S. stock market.
Only in 1931 and 1937 did the Standard & Poor’s Index fall by more than 38.5 percent, turning in a worse showing than 2008. The loss of trillions of investors’ wealth has them running scared as the new year begins.
Adding to the fear is a year-old recession that appears to be deepening with increased unemployment and uncertainty about the timing of a turnaround.
Now, however, investors face a new year: what are the possibilities for their portfolios?
Good follows bad
Many investors may say they expect the market to continue to decline. In fact, that happened after 1931: in the next year, stocks fell an additional 8.2 percent.
However, that is not the norm. Many of the best years in the stock market have come after miserable years.
Two of the best came after the worst years. In 1933, the best year ever, stocks rose by 54 percent. Two years later, they gained another 48 percent.
It is also notable that the second best year came at the height of a recession when stocks rose by nearly 53 percent in 1954. The same happened in the recession year of 1958, when stocks went up by 43 percent.
Roger Ibbotson, professor of finance at Yale, notes that the odds are always good for a positive year in stocks. The market has gone up during 59 of the 83 years since 1926, or 71 percent of the time. Moving the time horizon out over five and ten years increases the odds of positive returns.
Although there is no way of knowing when the market will begin to rise again, Ibbotson urges investors not to wait to invest until things are clear. “Unless you have more knowledge than the market, the long run starts now,” he wrote in Wealth Manager magazine in December.
The last big bear
It is also instructive to look at the last severe recession and bear market to hit the United States.
Back in 1973-1974 the market fell by 43 percent over 21 months. This was also the last time that the U.S. economy posted three consecutive quarters of negative growth in Gross Domestic Product, a measure of the growth or decline in all goods and services.
The first decline in GDP occurred in the third quarter of 1974, well after the stock market had experienced most of its decline. The economy went on to contract for another two calendar quarters.
However, an investment made in the S&P 500 Index during that first quarter of economic decline in 1974 would have returned almost 31 percent over the next year, notes U.S. Trust, a subsidiary of Bank of America.
“The point is that markets bottomed well before the economy,” U.S. Trust says. “It goes without saying 2008 is quite different from 1974, but the concept of markets looking forward will apply at some point during this bear market.”
Policy response
Many experts also note that the federal government has taken, and promises to take, significant action to shore up the economy and financial markets.
During the last quarter of 2008, significant easing in interest rates, increase in money supply and financial backing for financial institutions took place. The incoming Administration has pledged to spend significant sums to spur the economy.