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The chart on this page shows this much better than I can attempt to describe.
An investor would have been much better exiting the markets in 1900, 1929 and 1966 than remaining invested until the cycle lows of 1903, 1932 and 1975. In particular, let us focus on the most comparable previous major downturns. An investor who decided to hold and wait for the recovery after the market crash of 1929 (when the market fell around 35% from the peak to the year end) would have incurred a further loss of 34% in 1930 and then another loss of 53% in 1931. In fact, by the time the low was reached in 1932, an investor who stayed with the market would have seen the value of $100,000 reduced to just $10,814. An investor who had simply exited the Dow after the initial carnage of 1929 would have been almost SEVEN times better off. Our analysis of the data since then shows that if the Dow falls in a calendar year, there is a 38% chance that it will fall as well in the following year and the average fall in such a year is in excess of 20%.
Generally, the odds of a rising year after a falling year are reasonable; around three out of every five years following losing years tend to yield gains. However, the losing years tend to be heavy losses. Specifically, in a situation of the magnitude of the current crunch, precedent suggests that we should expect three more years of pain to follow and that the losses of 2008 might be less than half way down to the bottom.
We would emphasise that every situation is different - we have never exactly been here before and investment opinion is fiercely split as to what could happen next. But to say that history would vindicate a passive holding strategy at this point is completely misleading.
The cost of making the wrong choice at this time can be devastating - this is not a short term problem. Again, let us look to history for guidance. From 1900 to 1943, the Dow yielded an annual rate of return of just 2.3% per year. In real terms, there has been a fifty year period when the Dow returned less than 0.5% per year. In more recent times, from 1962 to 1982 the DJIA increased at a rate of just 2.4% per year. These are the dangers of buy-and-hold investing.
Now let’s look at the flip side of the coin. Without doubt, there are also good times. Simple maths dictates that there is a 60% chance of making money following a bad year. However, it is choosing where to go and what to do so as to reduce your risk that makes the difference.
In Summary
I would highlight there is still good money to be had. For instance, distressed property funds and distressed corporate bonds - these offer exceptional opportunities at clearly defined risks to the analytical buyer at the right time. Gold still looks good as does the multi-asset class approach. For those with a more adventurous outlook then Venture Capital and Private Equity can offer good returns but the potential downside is big as well.
The biggest shake up in the global economic landscape since the onset of the Great Depression has caused us to make a number of changes to our portfolios and we anticipated this scenario … any portfolio that was not positioned for these momentous events and yet still is not reacting is holding assets that have no relation to the prevailing economic situation. We fail to see how that can make any kind of sense from a risk-adjusted perspective. To our way of thinking it makes no sense to do nothing when the world is changing so quickly. Ostriches may bury their heads in the sand but good portfolio managers remain vigilant at all times - never more so than now!