Why Avoiding Stock Market Collapses Is So Difficult
There are significant costs to poorly timing the market. However, this does not stop many investors from trying since there can be significant benefits to getting it right. There are lots of data points around why it’s so difficult, but I think the most underestimated reason is that even if we can identify the potential triggers of a market collapse, we often don’t know how or when they will be resolved.
Take the 2020 stock market crash, which was caused by the COVID-19 pandemic. Some called for the next great depression as they saw no end to the death toll that was exponentially increasing and the devastating impacts it would have on the economy. Very few foresaw the level of government intervention that would occur in response, including stimulus packages and quantitative easing measures that we had never seen before.
Getting ahead of these collapses is difficult because most major events end up becoming non-events, as resolutions come quickly. Just recently with the collapse of SVB, the stock market began to sell off on the news. If SVB depositors had not been made whole, there was a significant chance it would have created a much larger financial collapse. Then over a weekend, FDIC insurance limits were completely ignored and uninsured deposits were covered by the government. In hindsight, it may seem obvious what the solution was, but in real-time the solution was murky at best.
This happens just about every year in the stock market. A significant risk looms, and then a resolution is found. Below is a table of some of the stock market corrections since 1950 that did not turn into a full bear market and the resolution that helped the market recover.
While there are several other instances that did turn into significant bear markets (hyperinflation in the 70s, Black Monday in 87’, tech blow-up in the 2000s, and financial crisis in 2008), most of the events were quickly resolved due to a resolution that few saw coming ahead of time.
Unfortunately, the most significant market downturns of 20+% are caused by small “tail-risk” events that occur infrequently and without warning. When you decide to invest in the stock market, this is the entry fee you pay for what have been great historical long-term returns.
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.