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When will the stock market go down?

A reader asks:

Since Ben is a data junkie, does he have any data or opinions on when the market goes down? Is the saying ‘catch a falling knife’ always true?

Guilty. I am a data junkie.

I can not help it.

I know you cannot predict future based on historical data, but you can analyze present and try to calculate reasonable probabilities from past. Past data doesn’t tell you what will happen, but it can help prepare you for what might happen.

The basics are pretty much useless as far as the bottom of the market is concerned.

The only real difference is what type of correction we are in – bearish or non-bearish.

Non-recessive corrections are much milder than those caused by recessions. This is S&P 500 data since 1950:

The reforms that take place outside a recession in the economy are shallow and small. This downturn makes sense when you consider how much financial pain homes inflict during your typical period.

Obviously, the hard part here is knowing whether or not you’re going to go into a recession. It’s hard to tell most of the time (when Tom Hanks contracted COVID, the NBA called its season off and everyone was told in no uncertain terms to stay home for 8 weeks in a pandemic).

But suppose you have the foresight to be able to predict the economic environment. You still won’t be able to use the fundamentals to nail down.

This is a list of non-recession reforms going back to 1950, with the CAPE ratio, P/E ratio, and dividend yield at the bottom of those improvements:

The only thing that rests here is that valuations were very low and dividend yields were very high back in the day. Otherwise, there is no clear pattern where you can choose a valuation metric that tells you when the bottom is about to hit.

It is interesting to note that bear markets are rare outside of a recession. There have technically only been two since 1950 (though I’ve seen four times we were close):

Never say never, but unless the economy goes into recession, it seems the current environment is more likely to improve than crash.

Now here’s a look at the bearish corrections:

There are no lines in the sand when it comes to this stuff.

Not only are all market environments different but humans are unpredictable by our nature. And we become even more unpredictable when we are losing money and panic.

So price is arguably your best indicator, but even technicals are declining as an indicator of when the selling pressure will end.

The volatility in the markets tends to be clustered during a downtrend. That’s why we see the biggest days And The biggest downturns in history occur during bear markets. When people panic, the price volatility is big.

This is why so many traders say that “the markets don’t come down on the big days.”

And it makes sense in theory… until you realize that the last two bear markets did the same. In 2018, the S&P 500 was up 5% in the trading session the day after Christmas, after falling 19.8%. It never looked back.

The March 2020 low came up 9.4%. Nobody really thought it was down but it was. The stock was up 1.2% and 6.2% over the next two days (for a total of 17.6% gain in just 3 days) and we were out of the race.

I wish I had a secret sauce to choose from, but even if there was some formula it would eventually stop working when enough people learned about it.

It’s always impossible to predict what the stock market will do in the short term, but for some reason investors try even harder to predict what will happen next during a correction.

You want your hands on the steering wheel when the excrement hits the fan. It gives you a sense of control over predicting what will happen next, even if that control is an illusion.

In 1966, Warren Buffett was still running his investment partnership.1 The stock market corrected after the Dow broke the 1,000 level for the first time that year. This improvement would eventually reach a loss of over 20%.

There were some new investors in the Buffett partnership who were a little nervous after experiencing its first shortfall. He called on Buffett to warn that the market would go down even further.

He responded by raising two questions in his next letter to investors:

(1) If they knew in February that the Dow was going to 865 in May, why didn’t they include me; And,

(2) If they didn’t know what was going to happen in February three months earlier, how would they know in May?

Buffett continued:

Let me suggest again that the future has never been clearer to me (call us when the next few months are clear to you — or, for that matter, the next few hours).

The future is not clear to any of us, no matter how confident we are in our claims.

The bottom of the market will only be known with the advantage of retrospective (and it will appear crystal clear after the fact).

We discussed this question on this week’s Portfolio Hedge:


I also had Bill Sweet with me to discuss how to reduce taxes in retirement and how to handle clients during reform.

Further reading:
Returns from the Bottom of Bear Markets

1Buffett bought Berkshire Hathaway in 1965 but did not close their investment partnership until 1969.

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