After Deep Sell-Offs, Follow Sharp Rallies?

In the three month period between Oct 19th, 2007 and Jan 18th, 2008, the S&P 500 (SPY) index fell 14.1% and the Russell 2000 Value Index (IWN) fell 19.5%. To understand what is likely to happen next, I studied the top 10 worst three-month-sell-offs since 1950. These sell-offs ranged between -13% to -30%. I found that in 8 out of the 10 occasions, the S&P 500 index rebounded by more than 20% in one year. Small Cap Value stocks did even better. The Fama & French Small Cap Value Index rallied more than 30% in one year in 8 out of the 10 occasions. In the other two occasions, it increased 6.6% and 24.1% respectively. (See Table below.)

A market sell-off is not a risk

As Demonstrated by history, most of the worst market sell-offs were followed by a substantial rally within a year. Many investors panicked and fled to cash at the nadirs of the sell-offs. By the time they mustered enough courage to get back in, they had missed the rallies. If you want to achieve long-term investment success, treat a market sell-off as an opportunity, instead of a risk.

One-year returns after the worst 3-month sell-offs

click to enlarge

Data source: Fidelity MARE group, Kenneth French data library

Disclosure: Author holds positions in the above-mentioned ETFs

Comments

[techy:]

i wonder if macroeconomic factor is even supposed to be considered, or we merely observe history without the context and jump.

what if this time we are still in 2000-2002 style long term correction followed by stagnation.....since economy is really hurting?

i am going to stay in cash till economy looks good.

2008 Feb 08 12:13 PM