WSJ - Historical Perpsective on Stock Market Corrections

Be Careful Buying January 17, 2008 by Brett Arends, Wall St Journal

Wall Street, as measured by the broad Standard & Poor's 500-stock index, has now fallen about 12% from its peak -- the record level reached just last October.
Many investors assume a stock market "correction" of 10% or more is automatically a great buying opportunity. But that's really a view we've inherited from the big bull market of the 1980s and 1990s.
To get a longer perspective, I looked at all 10% stock-market corrections going back to 1950. I found 20, including the current one. (Yes, they are surprisingly common.)
The big lesson? They don't always pay off as well as you'd hope. In fact, Wall Street on average rose less in the five years following such a correction than it did at other times.
The average five-year price rise following the 19 corrections from 1950 to 2000 was 37%. But the average five-year price rise throughout the entire period was 52%. So much for being rewarded for taking a risk.
And there was wide variation. Let's compare two periods when stocks had fallen 10% from their peak. Those who jumped into the market in April 1973 were still down 16% by April 1978. Those who bought in June 1950, on the other hand, more than doubled their money over the next five years.
This all ignores the effect of dividends, which will smooth the results somewhat. (Usually the lower the stock market, the higher the dividend yield). It also ignores the effect of inflation.
But many investors simply assume that the stock market tends to rally sharply in the years following a selloff. It frequently doesn't.
The reason is that some declines proved brief, lasting a few months at most. (Does anyone remember the slump of October 1955?) Others, though, proved to be a harbinger of big, grizzly bear markets -- like those that began in 1972 and in 2000. On both occasions, the stock market went on to fall by nearly a half before bottoming out.
None of this should scare you away from the market. Long-term investors should probably take advantage of the stock market selloff right now to add to their holdings. But they should think twice before rushing to invest.
Unless you possess a crystal ball, the best way to beat a stock-market downturn is with a three-step plan.
Buy.
But buy small.
And buy often.
Write to Brett Arends at brett.arends@wsj.com1

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