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A Stock Market Crash or Correction Is Inevitable -- History Says So

By Sean Williams - Updated Jun 10, 2020 at 9:43AM

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Historical and economic data would seem to concur that equities are in for a rough patch, but that's no reason to panic.

It's an absolutely wild time to be an investor. It could be argued that in a span of less than four months, investors witnessed about a decade's worth of volatility.

The physical and financial toll tied to the COVID-19 pandemic led to an incredible amount of selling pressure in the broad-based S&P 500 (^GSPC 0.04%) by mid-February. After closing at an all-time high on Feb. 19, the benchmark index proceeded to lose 34% of its value in a stretch of just 33 calendar days. The 17-trading-session decline into bear market territory, as well as the expediency of the 30% drop, mark the swiftest descents from a recent high in history.

But just as quickly as the stock market fell off a cliff, it seems to have reestablished a brand-new bull market. Over the past 11 weeks, the S&P 500 has rallied more than 40% off of its March 23 lows and even has its all-time high within sight.

The question is: Can this immense rally last in the wake of weak economic data, or should investors expect another stock market crash or correction? History would suggest that the latter is inevitable.

A snarling bear standing in front of a plunging stock chart.

Image source: Getty Images.

Statistically speaking, crashes or corrections following a bear market are normal

According to data provided by Wall Street analytics company Yardeni Research, there have been eight official bear-market declines (a non-rounded drop of at least 20%) since 1960 in the S&P 500, not counting the COVID-19 bear market. In the three years subsequent to each of these previous eight bear markets, or until the next bear market hit, if less than three years, there were 13 official stock market corrections of at least 10% (again, not rounded). On average, the bounce-back from a bear market is going to feature either one or two 10% to 19.9% drops in the S&P 500.

For example, the Great Recession wiped away almost 57% of the value of the S&P 500, before bottoming out in March 2009. Though in hindsight, we know the rally from those lows was ferocious, investors put up with a 16% decline spanning 70 calendar days in 2010, and a 19.4% drop covering five months in 2011.

Also, following the end of the dot-com bubble in 2002, the market almost immediately corrected for 104 calendar days after a double-digit-percentage bounce for the S&P 500 from its lows.

The point being that anytime a new bull market is established, volatility doesn't suddenly disappear.

A businessman holding up a cardboard sign that reads, Looking for a job.

Image source: Getty Images.

There are fundamental reasons supportive of a correction or crash

One of the weird quirks about Wall Street and the stock market is that it's always forward-looking. It's almost always the case that equities bottom out well before the U.S. economy hits its trough. But there's little denying how wide the gap is between Wall Street and Main Street at the moment, which leads to a strong likelihood of an eventual downside in equities.

Aside from the fact that historical data shows a crash or correction to be highly likely within three years of a new bull market beginning, perhaps the biggest fundamental threat to the U.S. economy is the upcoming end of certain aspects of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act, for short).

When the CARES Act was passed in late March, it apportioned $260 billion to expand the unemployment benefits program. This expansion entailed sending approved beneficiaries $600 extra a week for up to four months. But this extra $600 a week is set to end July 31. As of May 23, there were almost 21.5 million continuing claims (i.e., people receiving unemployment benefits), per the U.S. Employment and Training Administration, which suggests that the economy is nowhere near healthy. When these benefits stop, it's a near certainty that, without additional stimulus, we'll see a dramatic increase in rental, mortgage, and loan delinquencies. 

It's also not unreasonable to expect the U.S. economy to ramp up slowly throughout the remainder of June and into the third quarter. As we've witnessed from the opening of nonessential businesses throughout most of the country, many are not functioning at full capacity, and consumers are still far too scared to part with their cash. In April, the personal saving rate in the U.S. hit 33%, which is nearly double the all-time record of 17.3% set in May 1975, shortly after the oil embargo. If people aren't spending in a consumption-driven economy, that's a bad sign. 

A smiling woman staring off into the distance while holding up the financial section of the newspaper.

Image source: Getty Images.

Here's what smart investors do when the stock market crashes or corrects

If the historical data suggests that some form of correction is likely coming, and the economic data appears to concur, you might be thinking that the best thing to do is tuck your tail between your legs and run for the hills. But that's not what smart investors will be doing.

The first thing to do when the stock market corrects (aside from realizing that corrections are a normal part of the investing cycle) is to review your initial investment theses throughout your portfolio. You'll find that, more often than not, the reasons you've bought into a company haven't changed just because investor sentiment has been temporary hijacked by the latest worry. It rarely makes sense to sell great companies during periods of panic.

The next thing to do is ensure you have dry powder at the ready. Billionaire investing mogul Warren Buffett, who's been the CEO of conglomerate Berkshire Hathaway (BRK.A 0.57%) (BRK.B 0.70%) for more than five decades, has always been a strong believer in having a healthy cash position for periods of panic and fear. In fact, Buffett can't even repurchase Berkshire Hathaway stock unless both he and his right-hand man Charlie Munger agree it's intrinsically cheap and Berkshire Hathaway has at least $20 billion in cash, cash equivalents, and marketable securities at its disposal. Buffett has historically made some of his best investments during stock market corrections and crashes, which should incentivize you to always have some cash at the ready for investment.

Lastly, take a deep breath. Despite undergoing 38 official corrections over the past 70 years, the S&P 500 has put 37 of those corrections firmly in the rearview mirror. Eventually, the same will be true for the COVID-19 crash.

Although a correction or crash may be inevitable, that's no reason to deviate from a successful buy-and-hold strategy.

Sean Williams has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short June 2020 $205 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.

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