A guide to stock market recoveries

If market downturns scare you, rest assured you are not alone. Bear markets can certainly be extraordinarily difficult, but they can also offer opportunities. Investors who manage to stick to their long-term plan tend to be rewarded when markets recover.

We hope the following article helps you regain confidence. In it you will find:

• Three key facts about market recoveries.
• Three mistakes investors should avoid.
• Three facts about market recoveries

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Fact 1: Recoveries have been far longer and stronger than downturns

The good news is that bear markets have been relatively short compared with recovery periods. They can feel endless when we are in the middle of one, but in reality their impact has been far smaller than that of bull markets.

Although every market downturn has its own characteristics, the average length of bear markets recorded in the United States since 1950 has been 12 months.

Bull markets, by contrast, have lasted more than five times longer on average. The difference in returns has also been spectacular. While bull markets have posted an average gain of 265%, recovery periods are rarely free of difficulties. Investors often have to contend with alarming headlines, considerable market volatility and further market declines along the way. But investors who manage to stick to their investment plan and look past short-term market instability have always been better positioned when the recovery finally arrived.

Fact 2: After sharp declines, markets have recovered relatively quickly

We do not know exactly what the next recovery will look like, but historically markets have rebounded strongly after steep falls. We analysed the 18 largest market declines since the Great Depression and, in every single case, the S&P 500 index was higher five years later. The average annual return recorded over those five-year periods exceeded 18%.

Market returns tend to rise sharply after the steepest declines, bouncing back quickly from the lows. The average return recorded during the first year following the five largest market declines since 1929 was 70.9%, which highlights how important it is to stay invested and resist the urge to leave the market during periods of volatility. We are talking about the average return during the recovery period, but each of these periods was different from the others, and a future recovery could also turn out to be weaker.

Fact 3: Some of the world's most important companies were founded during market recoveries

Many companies started out in difficult economic times and have since become household names.

To name just a few: McDonald's was born in 1948, after the downturn that followed the US government's demobilisation of the wartime economy.

Walmart appeared some 14 years later, around the time of the 1962 Flash Crash, when the S&P 500 index fell 27%. Airbus, Microsoft and Starbucks were founded during the stagflation era of the 1970s, marked by two recessions and one of the worst bear markets in US history. Shortly afterwards, Steve Jobs went into his garage and created a small computer company called Apple.

History has shown that strong companies find a way to survive, and even grow, in times of difficulty. Companies that can adapt to challenging conditions and emerge stronger from them have frequently offered attractive long-term investment opportunities.

Bottom-up fundamental analysis is the key to distinguishing the companies that can lead a market recovery from those more likely to be left behind.

Three mistakes investors should avoid

Mistake 1: Trying to time the market

What matters is investing for the long term, without trying to predict how markets will behave. If an investor exits the market while it is falling and does not get back in at exactly the right moment, they will be unable to capture the full potential of the subsequent recovery.

Consider, for example, a hypothetical $10,000 investment in the S&P index made on 1 July 2013 and held for ten years. Staying invested through the two bear markets that occurred during that period may well have been difficult; but the patient investor would have almost tripled their money. Had the investor tried to time the market and missed any of the "good" days, their long-term results would have been significantly affected. The more "good" days they missed, the more opportunities they would have wasted.

Investors who prefer not to commit all of their capital at once may want to consider a regular investment plan during periods of volatility. In bear markets, regular investment plans allow investors to buy more shares at a lower average cost, and when markets rise those additional shares can increase the value of the portfolio.

Mistake 2: Being swayed by negative headlines

Today's economic and geopolitical challenges may seem unprecedented, but a look back through history shows there have always been reasons not to invest. Despite the headlines, the long-term trend of the market has always been upward. In fact, the great investment opportunities often emerge precisely when investors are at their most pessimistic.

Consider a hypothetical investment in the S&P 500 index on the day Pearl Harbor was bombed, 7 December 1941. Someone who had held that investment for the following ten years would have earned an average annual return of 16%. Likewise, a hypothetical $10,000 investment in the S&P 500 index on the day Lehman Brothers filed for bankruptcy, 15 September 2008, would have grown to more than $30,000 ten years later. History offers countless examples of this.

Mistake 3: Focusing too much on the short term

Volatility feels especially uncomfortable when we fixate on the market's short-term ups and downs. It is far better to widen your time horizon and focus on the long-term growth of your investments and on your progress towards your investment goals.

Look at the chart below, which shows different perspectives on the same hypothetical investment. The short-term view is the one many investors apply to their portfolios: chasing returns over short periods of time. The long-term view covers exactly the same investment period, but shows the annual change in the value invested. From this perspective, the short-term fluctuations of the first chart are smoothed out over time, and the picture of a growing portfolio becomes much clearer.

If you are looking to optimise the management of your wealth, the best approach is to work with a financial adviser you can TRUST, who will help and guide you along your investment journey. If you would like to get in touch with us, you can do so HERE.