Surviving Stock Market Storms: A Wise Guide for Navigating Market Turmoil and Achieving Long-Term Profits
By Thomas Romig *
Market turbulence: A risk or a potential gain?
Stock markets occasionally endure turbulent phases that spark fear and panic among investors. During these tumultuous times, stock prices plummet, leaving investors with gut-wrenching consequences. Yet, despite these disheartening scenarios, stock market turmoil can be an opportunity in disguise. By taking a closer look at history, long-term investors can prepare themselves to navigate market turbulence, capitalize on opportunities, and achieve profitable returns over time. This article focuses on the historical patterns of the US stock market to provide insights for modern investors.
Since 1945, there have been twelve bear markets in the US, with the S&P 500 marking the threshold of more than 20% price decline [1]. They were generally instigated by real-world issues or unexpected shocks that shaken investor confidence. Often, but not always, bear markets coincide with economic recessions: as corporate profits decrease, unemployment rates rise, and economic growth expectations weaken. For instance, the oil crisis of 1973/74 exemplifies this dynamic; soaring energy prices led to stagflation, causing the S&P 500 to plunge by 48% [1].
Bear markets ignited by interest rate hikes have also been recorded in the past. For example, the resolute interest rate hiking cycle led by the US Federal Reserve in the early 1980s, aimed at deflating rampant inflation, resulted in a recession and substantial stock market losses [1]. Most recently, in 2022, fears of increasing interest rates and looming economic slowdown caused US markets to plunge into another bear market, recording a loss of roughly 25% [1].
Beyond cyclical fluctuations, structural imbalances and speculative bubbles can trigger significant market corrections. The bursting of the dot-com bubble in 2000 offers a striking example. After years of irrational exuberance in the tech sector, markets reacted sharply: the S&P 500 lost about 49% in value between March 2000 and October 2002, while the Nasdaq index dropped by approximately 78% [1]. Only a few years later, the US mortgage crisis evolved into a global financial crisis. The collapse of the mortgage market sent shockwaves throughout the international banking sector, causing the most severe post-war stock market crash – the S&P 500 lost approximately 57% between 2007 and 2009 [1].
Outside factors, such as wars, geopolitical conflicts, trade wars, and pandemics, can also initiate sudden market disruptions, even when the fundamental economic landscape seemed strong. The 2020 outbreak of COVID-19 resulted in an unprecedented stock market crash: within a month, the S&P 500 lost roughly 34% of its value – an unexpected speed and scale unseen before [1].
The Art of Rebuilding: Key Factors of Recovery
Despite various causes and patterns of severe stock market crashes, a common trend surfaces: each significant correction has given way to stock market recovery and record-breaking highs [1]. But what factors contribute to this astonishing resilience?
An essential driver lies in economic fundamentals. Economic downturns and crises frequently trigger adjustment processes that have a stabilizing effect over time. Governments take a proactive stance with investment programs and fiscal stimuli, while central banks support the economy through interest rate cuts and liquidity injections [1]. For example, the massive interventions by central banks and governments following the global financial crisis paved the way for a long-term economic recovery. Fast-forward to the corona shock, governments and central banks again responded with an unprecedented package of monetary and fiscal measures, resulting in a remarkable economic recovery within a year.
Moreover, market corrections often prompt a reevaluation of companies. Exaggeration is reduced, and fundamental risks are priced correctly, while inefficient business models disappear from the market. Innovative companies, on the other hand, emerge stronger from crises. Following the dot-com bubble burst, for example, successful technology companies managed to establish themselves on the cleansed market and later became global market leaders [1].
Market psychology also plays a significant role. After periods of tumultuous uncertainty, a rapid transformation of sentiments commonly follows. Once fear abates and initial price increases become noticeable, many investors forge ahead by buying up stocks [1]. Coupled with confidence in supportive central bank policy, a momentum can develop that further propels recovery [1].
Historical Insights for Modern Investors
Studying the historical development of bear markets underscores the long-term robustness of stock markets. Despite the varying durations of the recovery after large-scale price drops – ranging from the corona crash, which took merely seven months to recover, to the oil price crisis of 1973/74, which required approximately seven and a half years to reach pre-crisis levels – in the median, significant downturns recovered quickly: in two to three years, prices generally returned to pre-crisis levels [1].
Interestingly, the returns after significant price declines show remarkable outcomes. Investors who jumped onto the market during periods of extreme volatility – specifically during a bear market with a decline of more than 20% – have historically enjoyed above-average returns. In the first year after the bear market, the average return was around 14%, while returns stood at +53%, and +133% after five and ten years, respectively [1]. For comparison, the average annual growth of the S&P 500 since 1945 is 8% [1].
Which lessons can investors glean from history in today's scenario? First and foremost, external shocks such as shifts in US trade policy cannot permanently impede stock markets. The yin and yang of global power dynamics and supply chains will fluctuate in the future, but companies can adapt. Moreover, US politics cannot escape the scrutiny of financial markets, forced to readjust its economic policies accordingly. The temporary suspension of many tariffs in the midst of surging U.S. Treasury yields acts as a clear sign [1].
Crises are an innate aspect of stock markets. They cleanse the competitive landscape and empower the innovative prowess of companies [1]. In times of high volatility, they can present enticing opportunities for long-term and high-risk investors to achieve above-average returns [1]. However, it is crucial to remember that interim losses can be considerable, and crises may persist for years. As a result, it is vital for investors to make investment decisions based on their personal risk-return profiles [1]. Evidently, long-term oriented investors with a higher risk tolerance may strategically exploit phases of high volatility, while conservative investors may derive more benefits from a broadly diversified asset allocation [1].
Our esteemed guest author Thomas Romig is the Chief Investment Officer Multi Asset at Assenagon.
Additional Insights: Navigating Market Turmoil
Government and Central Bank Intervention: Impact on Market Recovery
- Circuit breakers: These trading suspensions can help prevent panic-driven sell-offs and promote market stabilization during high volatility periods [3].
Market Psychology: Managing Sentiments in Times of Crisis
- Fear and panic selling: Panicked selling can amplify losses; a long-term perspective is key to ensuring rational decision-making [3].
- Complacency and speculation: As with the 1929 crash, overconfidence can lead to overvaluation and subsequent corrections [4].
Crisis Management: Climbing the Ladder of Success
- Adaptation to structural shifts: Remaining open to technological advancements and regulatory reforms can improve your understanding of market opportunities [4].
- Managing risks and investments: A balanced approach, considering both risk and return, can help minimize exposure [4].
Conclusion: Learning from History to Thrive in the Future
With a keen understanding of historical lessons from US stock market crises, modern investors can come prepared to navigate market turbulence, embrace opportunities, and establish sustainable returns over the long haul. By recognizing these trends and molding strategies accordingly, investors can better weather the storms of capitalism and emerge victorious.
References:
- Stock Market Irritations – This article is the base for our rewritten story.
- Investing During Crisis - Insights into crisis management, market psychology, and government responses during economic downturns.
- Stock Market Crashes in History – An in-depth discussion of key stock market crashes throughout history.
- Sources for Financial Market Analysis – This study highlights how financial markets function during crises, focusing on investor sentiment, market psychology, and fundamental analysis.
Investing in specific areas such as finance, investing, and the stock-market during stock market turmoil can offer unique opportunities for long-term investors. By closely examining historical patterns, such as the 12 bear markets in the US since 1945, investors can gain insights to navigate market turbulence, capitalize on opportunities, and achieve profitable returns over time. Evidently, long-term oriented investors with a higher risk tolerance may strategically exploit phases of high volatility to potentially gain above-average returns, while conservative investors may benefit from a broadly diversified asset allocation.
