Is it a Normal Decline or the Next Big One?

I don’t want to go through that again.

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Counseling investors over the past five years has been an interesting experience. On one hand, it’s nice to know that we made it through “the big one” together. I assumed that if investors can hold on to their belief in the markets during an ordeal like the recent recession, they can make it through anything. What I have found is that investors are still on edge and every bump along the way feels like the beginning of another meltdown.

Stocks are always fluctuating up and down, but over the long run, they have moved higher. In the period from 1980-2012, the S&P 500 finished with positive gains for the calendar year 25 times out of 33 years.* The largest intra-year declines for each year ranged from 3% to 34%, with an average decline of 14.7% over the period. Yet the average return per year over the same period was 9.4%. Even during the 25 positive years, the average intra-year decline was 12.0%. Significant drops in stocks are fairly normal occurrences and don’t necessarily mean that further declines are coming.

A classic example of a regular intra-year decline occurred in 2012. For the third straight year, stocks began to decline in May and continued in June. There was plenty of negative news and uncertainty to be concerned about. Unemployment was stubbornly high and not budging much. The recovery was moving along slower than hoped for. A Presidential election dominated the news which led to uncertainty until the night of the election. The Eurozone credit mess did not come close to being resolved. In July, the market started to recover and didn’t look back. The S&P 500 ended the year with a gain of 15.32%.**

The phrase I hear often when declines begin is “I don’t want to go through that again.” The problem is that a normal intra-year decline begins the same way as a bear market, with stocks going down in value. By not sticking with stocks, investors are favoring the far less likely scenario of a collapse than the more common occurrence of a normal decline in the midst of a positive growth year.

* Source: Standard & Poor’s, FactSet, J.P. Morgan Asset Management
** Source: Lipper, Inc.

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