Not every correction ends in calamity…

After witnessing the stock market crashes of 2000 and 2008, it’s understandable that investors have become fixated on “the next big one”. It is rationale to understand the investment risks beforehand and plan ahead. Volatility in stocks just comes with the territory and there is simply no way around that. What we can control is how we react during times of market stress.

If we understand that stocks can go down without it being a crisis, that is half the battle. And even though the 2000’s decade experienced two separate market crashes, historically this has not been the norm. Since the great depression of 1929 there has been many 10-20% corrections, but only a handful of crashes in those 80+ years. Although recency bias can make investing tough, most corrections do not end in calamity.

You are likely to hear and read many comparisons and predictions of disaster. This has been the case for the last five years, to no avail. To show how unfruitful these predictions are, it would take another 50% decline in the S+P 500 to get to the levels that were trading when these doomsday predictions came in vogue. But for every doomsday comparison there are more comparisons that ended just fine.

One such comparison is the Asian and Emerging Markets currency crisis of 1998. It began in 1997 and escalated into contagion by the summer of 1998. The brief timeline via PBS.org:

May 27, 1998
Russia’s financial system is stretched to the breaking point as panic-striken stock and bond markets continue to plunge, forcing the central bank to triple interest rates to 150% to avert a collapse of the ruble.

June 1, 1998
Russia’s stock market crashes and Moscow’s cash reserves dwindle to $14 billion amid unsuccessful attempts to prop up the ruble and pay off burgeoning debts. President Clinton pledges support for Yeltsin.

June 12, 1998
Japan announces that its economy is in a recession for the first time in 23 years.

June 17, 1998
The yen’s fall to levels near 144 to the dollar rattles Wall Street, prompting the US Treasury and Federal Reserve to intervene to prop up the yen. Japan and the US spend some $6 billion to buy yen in order to strengthen it. Clinton calls on Tokyo to quickly resolve its banking problems and stimulate the economy.

August 3, 1998
Wall Street reacts to the deepening crisis; the Dow plunges 300 points in its third-biggest loss.

August 11, 1998
The Russian market collapses. Trading on the stock market is temporarily suspended. World markets are rocked by fears of a financial meltdown in Asia and Russia.

August 19, 1998
Russia fails to pay its debt on GKO or treasury bills, officially falling into default. The IMF and Group of Seven (G-7) say they won’t provide additional loans to Russia until it meets existing promises.

August 21, 1998
Russia’s economic crisis shakes world markets, bulldozing stocks and bonds in Latin American and reverberating through the US and Europe. Russia’s Duma calls for Yeltsin’s resignation. Investors pile into US Treasury bonds as a safe haven from the storm, causing yields to drop to record lows.

August 31, 1998
After weeks of decline, Wall Street is overwhelmed by the turmoil in Russia and world markets. The Dow Industrial average plunges 512 points, the second-worst point loss in the Dow’s history

…..

May 12, 1999
The Dow Jones Industrial tops 11,000.

2015-08-25_1357

Any of this sound familiar? So how did the US markets hold up during these times? The chart above shows the details. The S+P 500 would fall about 14% in August of 1998 and then proceed to rally 29% into the first quarter of the following year.

Now it’s anyone’s guess as to how this current situation with China will play out. No two situations are ever 100% correlated. It’s very easy in hindsight to see what the best course of action was in 1998. But it couldn’t have been easy in the middle of the panic, when the outcome wasn’t certain.

The main point is that every market correction isn’t the beginning of the end. And every market rally isn’t the creation of another bubble. More often then not it is simply status quo for investing in a volatile and emotionally driven asset class.

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