What History Tells Us About Stock Market Declines

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Includes: SPY
by: Adam Freedman

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The start of 2016 hasn't been pleasant for investors. Fears of a weakening global economy and turmoil in Chinese markets have led stock markets around the world to nosedive. The S&P 500 index of large US stocks has fallen almost 8.5% over the past three weeks. Such declines can be painful, and it may feel like it's inevitable that markets will continue to head downward. But history suggests that investors who bail on the stock market at this point are likely making a mistake.

As we've noted in the past, when viewed in a broader historical context these kinds of declines aren't too unusual. During the past 25 years the S&P 500 has gone down by more 8% over a three-week period at least once in a majority of calendar years. It happened 4 months ago. It happened in 2011, in 2010, and numerous times during the financial crisis. It happened in 2003, multiple times in 2002, and multiple times in 2001. The list goes on and on.

Sometimes these rapid market meltdowns herald more losses to come. The US stock market fell dramatically in January 2008, for example, and the pain continued the rest of that year. But many other times the market bounces back. Plunging markets in early 2003 and early 2009 both were followed by massive gains years in the subsequent years.

More often than not when the market suffers such acute declines, it recovers fairly quickly. In fact, during the past 25 years when the S&P 500 index has fallen by more than 8% over a three-week period, it has averaged a gain of more than 17% during the next 52 weeks.

Of course averages don't tell us what's going to happen in any specific situation. It's certainly possible that this year could end up more closely resembling the financial devastation of 2008 than the vigorous rebounds of 2003 or 2009. But if history is any guide, selling stocks for fear of further losses is more likely to be a mistake than a wise decision.