Permit me to demonstrate.
Most stock-investment portfolios have endured a Muhammad Ali-like punch flurry in October.
Large-cap stocks – represented by the Dow 30 Average and the S&P 500 and NASDAQ Composite indices – are down 6% to 8% across the board for October in a market sell-off. Small-cap stocks have offered no defense. The Russell 2000 is down 9%.
The recent hard sell-off invokes more of the obvious: Will the market sell-off snowball into an avalanche? Is the beginning of a major market correction upon us?
Crystal balls are rarely crystal clear. Most are as opaque as a headlight lens on a 2002 Buick Regal. With that caveat out of the way, from what I see, the answer is “no” to both questions. Here’s why.
Corporate earnings continue to grow. Corporate earnings are growing to meet investor expectations.
Seventeen percent of S&P 500 companies have reported third-quarter financial results to date. The reporting companies have reported 19.5% blended year-over-year EPS growth. If 19.5% is the actual EPS growth rate for the quarter, it will mark the third-highest quarterly growth rate since the first quarter of 2011, according to FactSet data.
Optimism is further buttressed by level-headed investors.
The forward 12-month P/E multiple for S&P 500 earnings is at 15.9 based on FactSet estimates. The forward P/E multiple is below the five-year average of 16.3. The multiple was at 17.1 times forward earnings to start the year.
But what if I’ve misread my crystal ball? The market sell-off snowballs into a bear market. What should we expect and what should we do?
Morningstar data tell us that the average bear market lasts 18 months. It produces an average 40% drop in the S&P 500.
The S&P 500 dropped 43% during the bear market beginning late 2000 following the bull-market highs set in March 2000. The S&P 500 lost 56% of its value by March 2009. The highs seen in late 2007 weren’t seen again until March 2013.
To belabor the obvious once again, it’s best to avoid the bear market, but only if you’re assured of returning before the next bull starts its run.
If you return too late, you risk missing the “big pop” days.
Data compiled and analyzed by Index Fund Advisors show that big gains — the wealth-changing gains — are frequently concentrated in just a few days. If you miss even a finger-count of these “big pops,” your returns take a George Foreman-like pounding.
The table below covers the S&P 500 from Jan. 1, 1998 through Dec. 31, 2017. The hit returns absorbed for missing even a few big-pop days was hard indeed.
You might argue that timely selling means missing the worst-performing days. You wouldn’t be wrong.
If you had missed the 40 worst-performing days of the S&P 500 Index over the past 20 years, your return would have been 952% more than investors who stayed in the market every day throughout the entire 20 years.
Good luck identifying the worst 40 days. The odds of identifying those days only slightly lag the odds of winning a power-ball lottery. Your sales will likely ensure you miss the best 40 days.
Morningstar data tell us that the average bear market lasts 18 months. Bull markets have averaged 97 months. The start-market bias is up. A glance at a long-term chart of the S&P 500 confirms the bias.