How quickly can stocks rebound after a bad year?

• Level: For Advanced
• Reading duration: 15 minutes

Equity markets are the ultimate comeback kids. They’re forced onto the retreat one year in three on average – so as ETF investors we all know what it’s like to take some pain. But despite the hard knocks, equities normally come roaring back – the only question is how long does the rebound take? We’ve scoured investing’s history books to find out the answer to that question. But to ensure we’re not fooling ourselves, we’ve focussed on the very worst annual setbacks on record. If equities can shrug off the World Wars, the Great Depression, and wild inflationary periods, then we’ll probably be OK after 2022. If you’re a new investor then you may be shocked by the size of the losses inflicted on German, French, Italian, and Spanish investors during the darkest episodes of the Twentieth Century. We’ll compare those meltdowns with US and World equities too – as a salutary reminder of the importance of diversification. OK, it’s time to grit your teeth and hold the hand of a loved one, as we reveal the worst the markets can throw at you, and how long it took to come out the other side …

US - Top 10 Worst Annual Returns 1872 - 2022

The US’s worst calendar years reveal most of the major events that scarred markets over the past 150 years:

• World War One plus the influenza pandemic and high inflation that followed
• The Great Depression of the 1930s
• World War Two and post-war inflation (US losses were relatively light in comparison to other countries)
• The 1973-74 Oil Crisis
• The Dotcom Bust in the early noughties
• The Global Financial Crisis of the late noughties

Despite the human and financial cost of these tragedies, US equities have typically rebounded at speed – driven by the belief that market competition, innovation, and the desire to overcome our challenges translates into wealth and profits down the line. As the table shows, the markets put in a strong positive performance within one year of a major downturn in the majority of cases. After five years, investors were up in nine out of ten scenarios, and 100% of the timelines were positive after 10 years. The 10-year annualised return column shows that investors were making spectacular profits fully one-third of the time versus the US average annual return of 6.8%. Granted, four of the ten-year annualised returns could be described as sub-average, but all were happily in the black. As we’re all aware, the world’s sternest tests can take many years to resolve. But the table is testament to the strength of the US, and shows how investors are eventually rewarded for their patience.

The World – Top 10 Worst Annual Returns 1970 - 2022

To round off, let’s look at the resilience of globally diversified equities during a period mercifully free of world war catastrophe. The MSCI World index (as tracked by many ETFs) has suffered its share of setbacks since its launch in 1970. But the majority of the losses evaporated after three years. Two out of three of the negative 10-year scenarios are associated with the Dotcom Bust. Unfortunately, those investors ran into the Global Financial Crisis before making good their earlier woes. In the longer run, they did just fine. Although the 2001 investor had to wait for 14 years to reach profitability. The 1973 and 2002 investors were back in the black after 12 years, and subsequently enjoyed above average returns. Most of the other timelines in our World worst list had their returns super-charged on the rebound as shown by the 10-year annualised column. Remember that over 5% annualised is historically exceptional after inflation.

Hold the line and give it time

Of course, the historical record doesn’t tell us what will happen in the future and there are no guarantees. However, we’ve looked into the market’s all-time nightmare scenarios during this post. If even these calamities aren’t fatal then you can almost certainly overcome any difficult years that lie ahead. It’s also worth noting that there’s no significant connection between a bad year and the next year’s return. While our emotions may tell us to hunker down until the smoke has cleared, our head should tell us that markets can bounce back in a flash. And as we’ve seen, excellent opportunities await level-headed investors who can stay calm and pick up equities on sale. Finally, the numbers quoted are based on 100% equity portfolios invested entirely at a market high on the eve of disaster. There are vanishingly few people who invest like this. In the real world, results are much improved by implementing straightforward portfolio management strategies. For example:

• Strategic asset allocation
• Cost averaging
• Rebalancing