March 15, 2013
Could it happen again? Could your retirement plans end up in shambles, and your college savings tattered?
As investors see the stock market repeatedly climbing to new records lately, some people want to know that they will be safe this time. They'd like to get a taste of the action in the stock market, but they want guarantees that they won't get whacked again like they were from late 2007 to March 2009 — a 57 percent hit.
If you fear a reoccurrence and want assurances that it won't happen again, you will never get such certainty. Because the crash of 2007-09 was one of the worst in history, it's unlikely — but not impossible — that the next plunge will be as horrific. But some sort of downturn is a sure thing, even though it's not clear when it will occur or how bad it will be.
Academic studies show that even professional investors are very poor at predicting the future. When times are good, they expect the trend to continue. When times are tough, they don't imagine improvement until it's far along.
Still, analysts do watch for early signs of trouble in the market — signs like oncoming recessions or, just the opposite, too many people feeling like they can't lose.
When people see blue skies ahead they naively take excessive risks buying overpriced stocks. Ultimately that leads to a market plunge because stocks won't climb indefinitely if company profits aren't strong enough to warrant the stock prices. The downturn can be either what's known as a correction, or a 15 percent dip in the stock market, or a bear market, a lengthy plunge of 20 percent or more.
Now, analysts are comforted because investors are still skeptical of the stock market.
"If there is some good news out there, it is that a lot of the froth in the recent survey data has receded," said Gluskin Sheff economist David Rosenberg, noting a recent poll of investors by the Association of Individual Investors. Only 31 percent said they were bullish about the market, or expecting stocks to keep rising. Their curbed enthusiasm suggests stocks can keep climbing.
Investors who want guarantees need to be aware of the realities of stock market cycles. Bear markets happen about every 41/2 to five years. The average loss in such a market is 38 percent, according to the Leuthold Group.
That's unsettling, but bear markets happen only 34 percent of the time. Bull markets, which plump up 401(k)s and make investors feel good, happen 66 percent of the time.
Although people tend to think of their gains as keepers that should belong to them forever, the downturns are a natural part of investing — a result of cycles. In the cycles, exuberance fuels upturns for a while, and then stocks fall until bargain hunters show up and cause stocks to climb once again.
Since 1900, there have been 23 bear markets and, on average, investments have recovered in about 21/2 years, according to Leuthold Group research. But in the worst bear markets, like the 2007-09 one, the pain has lasted a lot longer. It was March 5, 2013, or more than five years since stocks started plunging in October 2007, before the market recovered its value.
In the 2000-02 bear market, stocks plunged 49 percent, and investors didn't get back to even until 2007. And after the 1973-74 bear market, investors had to wait 71/2 years.
That might be enough to scare you away from the stock market indefinitely. On the other hand, if you want to partake in climbs like the 120 percent gain since March 2009, you can follow a common financial planning practice: Since neither you nor your adviser will know when the market will dip again, financial planners simply suggest you hedge your bets by designing a mixture of stocks for good times and bad.
If, for example, a person had invested half of his or her money in the stock market (Standard & Poor's 500) and half in long-term government bonds, their average one-year loss over the worst five-year period tracked by Morningstar would have been just 2.8 percent.
If an investor had been more daring and invested 70 percent in stocks and 30 percent in bonds, the annual loss in the roughest five-year period would have been 6.3 percent.
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