Being an investor in 2020 has required a strong stomach and a determination to stick by your long-term investment thesis. Unprecedented levels of uncertainty caused by the coronavirus disease 2019 (COVID-19) whipsawed the broader market like never before this year. The 124-year-old Dow Jones Industrial Average (^DJI) has logged 14 of its 16 largest single-session point declines this year, along with eight of its nine biggest single-day point gains.
Will 2021 bring about the same level of volatility and, dare I say, another stock market crash?
Predicting short-term market moves is impossible, but historical data certainly gives us some clues about what to expect.
History suggests investors should prepare for more downside
Keep in mind the phrase used by pretty much all investment firms: "Past performance is no guarantee of future results." Still, history suggests that another stock market swoon is on its way -- possibly in 2021.
According to data from market analytics company Yardeni Research, there have been eight bear markets in the S&P 500 (^GSPC 1.30%) (i.e., declines of at least 20%) since 1960. In the three-year period following the bear market bottom in each of these declines, there were 13 instances when the S&P 500 corrected lower by 10% to 19.9%. Put another way, the typical rebound from a bear market bottom features one or two pretty sizable corrections or crashes of between 10% and 19.9%.
The data is even more convincing in recent years that we're going to see a sizable pullback in 2021. Since the beginning of 2010, the S&P 500 has undergone (at least) 15 separate pullbacks of 5.8% or more, with 11 of these swoons taking place in a span of 13 to 70 calendar days (two to 10 weeks). What this tells us is that, on average, we're seeing a sizable dip in the benchmark S&P 500 every 8.7 months, and that short-term emotional investing is what's pushing equities lower during these crashes and corrections.
Based solely on historical data, I'd suggest investors prepare for some downside in 2021.
These catalysts could weigh on the stock market
But it's not just historical data that investors have to worry about. Though the U.S. economy and stock market aren't joined at the hip, there are many external factors that could weigh on the market in 2021 and cause emotional traders to run for the exits.
The most obvious concern is the current surge in COVID-19 infections. This resurgence may well cause certain states to impose tighter restrictions, including a second lockdown. Equity markets have not been factoring in the possibility of another shutdown in key states like California or New York.
It's not just the potential shutdown that's concerning. When much of the U.S. shut down during the spring, lawmakers were quick to pass a monstrous economic stimulus package to aid small businesses, the unemployed, and working Americans. That response might be lacking this time around. Democrats and Republicans on Capitol Hill have been squabbling over the cost of a second stimulus package for almost four months, and President Trump might prove less incentivized to get a deal done with his term up in two months.
There are also concerns surrounding the development and distribution of coronavirus vaccines. Historical vaccine development shows that fewer than 2 in 5 experimental vaccines will be successful in clinical studies. We also don't yet know how doses of successful vaccines will get from point A to B (e.g., Pfizer's and BioNTech's vaccine needs to be stored at minus 112 degrees Fahrenheit). There's the real possibility that no amount of good news will satisfy investors, and there will be a sell-the-news type event when it comes to vaccines.
Here's what you should do with your money in 2021
With the deck potentially stacked against investors in 2021, you might think it prudent to pack up shop, but that's probably the worst thing you could do. Though stock market crashes and corrections can be unpleasant, they rarely last long. Think of them as the price of admission to the greatest wealth creator on the planet.
So, what should you do?
First, review your investment holdings and ensure that your initial or updated theses are still true. In other words, make sure that the reason(s) you bought into a stock is still valid today. If your original or updated thesis still holds water, there's no reason at all to panic if the stock market undergoes one of its many hiccups. Since operating earnings expansion drives equities higher over the long run, you should still be in good shape. Only if your investment thesis has materially changed is it a good time to consider selling.
It also wouldn't be a bad idea to get some dry powder at the ready. Since every single stock market crash and correction in history has eventually been put into the rearview mirror by a bull market rally, any sizable downside in the Dow Jones or S&P 500 represents an opportunity to pounce on high-quality and innovative stocks.
If a stock market crash does happen in 2021, as historical data suggests, be ready to go shopping.