Last week we highlighted dollar-cost averaging (DCA) as a means of mitigating market volatility. And with the bears in the ascendancy, it’s worth examining the possible duration of the market slump and the opportunity this affords investors.
Although it can be shown that the long-term trajectory of stock market indices is up over time, there will be periods when they oscillate wildly. A DCA strategy removes the possibility of committing all your capital to a stock or a fund at a high point for prices, smoothing out the intervals between market troughs and peaks.
If you’re already going down that road, or are thinking about employing it, you’re probably wondering how long the down leg in the market will endure?
The first thing that needs to be said is that it’s unprecedented for governments to knowingly pull the rug out from under investors, at least on this scale. There were certainly signs that the global economy was running out of steam in the lead up to the virus outbreak, but no one expected aggregate demand to fall off a cliff. Labour markets, which had remained buoyant in the early part of the year, are now experiencing levels of contraction not seen since August 1929, representing a major threat to the global economy.
A stock market index value reflects the level of confidence in the constituents’ future earnings prospects. With business and consumer confidence in the doldrums, it’s hard to imagine that the bears won’t be with us for longer than usual this time around. In other words, you will probably be able to gradually allocate a greater level of capital during the down leg than you would be able to during the average bear market, assuming you employ DCA.
The recent collapse in valuations has been triggered by an extreme left-field event, though some might argue that it merely exposed – rather too rapidly for most tastes – the usual inflated asset prices and irrational exuberance that prefigure major market corrections.
It’s impossible to tell how long the bear market is likely to last given that previous downturns have been the result of specific market conditions and events. But analysis from Invesco on the movement of the S&P 500 over the past six decades might shed a little light.
During that period the index has been subject to 10 bear markets, which had an average duration of 10.7 months and an average pullback of 34.3 per cent. That compares with an average bull market gain of 154 per cent over a span of 55.1 months. From peak-to-trough – 19 February through to 23 March – the index lost 34 per cent of its value, mirroring the long-term average, although you imagine the damage isn’t done yet. The index stood at 683 points in March 2009, against its current level of 2541, suggesting that a bottom is still some way off in the distance.
The longest bear market followed the stock market crash of 1973-74 and lasted a record 20.7 months. It bears some similarity with our current woes, in that it was certainly global in nature, precipitated by the collapse of the Bretton Woods system and exacerbated by a major oil crisis engineered by Opec in response to Israel’s victory in the Yom Kippur war. There is one significant difference in that inflationary pressures were diametrically opposed. The S&P lost 48 per cent of its value over the down leg, which may provide an optimal point at which to start building through DCA.
This is a unique situation, and everything depends on how rapidly – and the extent to which – regular commercial activity is resumed. The S&P 500 staged a mini-rally during last week, a move that was foreshadowed by a contracting CBOE Volatility Index (Vix), according to a recent update from US wealth manager Bill Gunderson.
It's difficult to gauge what constitutes a temporary effect when you’re effectively under house arrest, but if the Vix continues to drift lower it could signal that fear is giving way to a more measured approach to valuations, although this provides scant consolation.
