Are You Ready for Dow 9,400?

The Dow Jones Industrials (DJINDICES: ^DJI  ) have climbed to record highs on multiple occasions this year and are once again near their all-time high-water mark. Yet as good as the past several years have been for stock investors, you always have to be prepared for the risk side of the risk-reward equation to reassert itself.

Yesterday, we noted how by one historical measure, the Dow could easily climb to 19,000 without it being anything more than a typically average bull-market rally. Yet on the other side of that coin, investors also need to be aware of the possibility that a decline could send the Dow falling to 9,400 or below without being anything more than a typically average bear-market plunge.


Source: Wikimedia Commons, Jean-Pierre Lavoie.

Historically, what goes up must come down
When bull markets will end is notoriously difficult to predict. Some have taken just two or three years to run their course, while others have lasted a decade or longer. Despite the dramatic bounce from the financial-crisis-driven lows four and a half years ago, it's entirely possible that stocks could keep rising from here.

Eventually, though, bull markets have always given way sooner or later to bear markets, sending major market averages down by 20% or more. According to figures from Nobel Prize-winning economist Robert Shiller, you can find 15 previous periods in which downward-moving markets lasting three months or more and including at least a 20% drop from the previous bull market's high. Historically, the average loss under such circumstances has been 40%. That means if the bull market were to end today, you could expect on average for the Dow to drop to about 9,400, based on the recent highs in the Dow around 15,700.

Investors have gotten used to relatively short plunges that have quickly reversed themselves. For instance, as brutal as the financial crisis was, stocks hit bottom relatively quickly, with just a year and a half or so passing between the Dow's 2007 record highs and its early 2009 lows. By contrast, the average bear market has taken almost four years to play itself out. That means that a long time could pass before you were even aware that the bull market had ended, and even once it became clearer, you still couldn't bank on having it over quickly and painlessly.

Dow 2,400?
Of course, a 40% bear market drop wouldn't be history's worst performance. That honor goes to the period following the Crash of 1929, in which stocks lost 85% of their value. A similar drop would take the Dow down to 2,400.

The point, though, isn't to scare you into thinking that losses of this magnitude are inevitable. There have historically also been more modest declines even during bear-market periods. But part of stock market investing is being aware of the potential risk involved and understanding in advance how you'll respond if the worst-case scenario actually happens. In that light, being prepared by embracing strategies like portfolio diversification and asset allocation can help you survive the next bear market -- no matter when it comes or how bad it happens to be.

Don't give up on your portfolio
The one thing you shouldn't do in response to the threat of a bear market is to become paralyzed with fear. Unfortunately, millions of Americans did exactly that after the 2008 stock market crash, being too scared to put their money at further risk. Yet those who've stayed out of the market have missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.


Read/Post Comments (7) | Recommend This Article (20)

Comments from our Foolish Readers

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  • Report this Comment On October 20, 2013, at 10:47 AM, pvellozo wrote:

    It could go up. It could go down. What is the point of this article?

  • Report this Comment On October 20, 2013, at 2:47 PM, isonespal wrote:

    It wasn't that long ago when 9400 for the DOW looked pretty good. A friend said she was going to sell out of the market if the DOW ever got back to 9400. Of course it did and she didn't, thank goodness!

  • Report this Comment On October 20, 2013, at 7:12 PM, hollywoodlafl wrote:

    The market is artificially propped up and it must nosedive to correct.

    9000-10000 sounds about right.

    Maybe this will occur before or in March 2014.

  • Report this Comment On October 21, 2013, at 1:25 PM, slash32is4 wrote:

    or it must go up to 19,000 before it corrects

  • Report this Comment On October 21, 2013, at 1:38 PM, adlerc wrote:

    ...and specifically how should you prepare for the bear market? Since Motley is a good place for beginners to learn, it would be nice to give some idea or at least some links that provide strategies for preparing for the inevitable bear market.

  • Report this Comment On October 21, 2013, at 1:58 PM, HectorLemans wrote:

    Never go "all in"...that's the big lesson I learned from the financial collapse in 2008-09. You'll get burned in a bear market (everyone does), but keep buying a little at a time as prices go lower and always try to save a little extra for when people really panic so you can scoop up those bargains.

  • Report this Comment On October 22, 2013, at 12:42 AM, daveandrae wrote:

    I am well into my sixteenth consecutive year of buying and holding equities and I still don't know, or care, if the dow jones industrial average will touch 9,000, or 17,000 first.

    In this business, that which is most important, is not selling high or buying low. That which is most important is leaving your very best ideas undisturbed.

    The Cantor family sold the Coca-Cola business in 1919 for 2000 bucks. A year later, a 40 dollar investment was worth 23 bucks. Today, that same 40 dollar investment is worth 20.9 MILLION dollars!

    This assumes, of course, that you reinvested your dividends, paid the income taxes from another source and left the position, once again, undisturbed.

    Intelligent investors don't pull good trees up out of the ground just because they're fairly young and winter is coming. For history has shown time and time again that when the job is done correctly, that same tree will grow back even bigger and stronger next spring. Thus, the best time to sell out of a really good stock is, almost, never.

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