Market falls – lessons learned from past crises

Extreme share price moves, as we are experiencing now, are deeply unsettling. It can be tempting to exit the market, with a view to reinvesting when things calm down. But is this the right course of action? A study of historic data suggests that investors do better when they hold onto their investments through these periods of volatility.  

Historic stock market declines

The chart below shows that short-term downturns are not uncommon. In 25 of the 33 calendar years ending in 2018, the UK equity market has fallen by more than 10% at some stage during the year (indicated by the blue dot).

However, in most of these years, the full calendar year return has been positive (indicated by the green bar).  

^{Source: DataStream, FTSE, JP. Morgan Asset Management. Returns are based on local price only and do not include dividends. Intra-year decline refers to the largest market fall from peak to trough within a short time period during the calendar year. Returns shown are calendar years from 1986 to 2018. Past performance is not a reliable indicator of future performance.} 

Attempting to time the market

Returns in the weeks and months following very sharp drops can be strong as investor sentiment rebounds. This means missing the recovery can be costly.

The unfolding coronavirus crisis, and oil price slump, have resulted in some of the worst weeks for the UK's benchmark equity index since its creation in the 1980s. Falls of this extent were last seen during the financial crisis of 2008/9. 

The table below shows how the FTSE100 has behaved following the worst weekly falls in the last 35 years. 

Ten worst one-week falls for the FTSE100 with subsequent performance over 6 months and 1 year 

^{Source: Datastream, Cazenove Capital, 2020.  Past performance is not a guide to future performance.}

On average, stocks were 21% higher a year after these extreme weekly falls. They have not rebounded in every instance, but falls in subsequent periods have been modest. 

The tendency of markets to rebound following sharp falls – and the importance of these rebounds to returns – is reflected in longer-term performance numbers. 

Over the 30 years to the end of 2019, the UK’s FTSE100 has generated an annualised total return 7.8% per annum. However, missing the best 20 days in that period would have reduced the annual return to just 3.8%. Missing as few as the 10 best days results in a significantly lower return of 5.4%. 

An investor would have to be uncommonly nimble to buy back in at the optimal moment to capture the bounce that follows. Evidence shows just how difficult it is to do this with any consistency.