This has certainly been a year that the investing community won't soon forget. Unprecedented volatility caused by the coronavirus disease 2019 (COVID-19) pandemic initially cost the broad-based S&P 500 (^GSPC 0.59%) more than a third of its value during the first quarter. Amazingly, the steepest move into bear market territory in history was followed by one of the most ferocious rallies on record. In 12 days, when 2020 comes to a close, it'll likely be with the S&P 500 delivering above-average annual gains.
The question is, can the profit party continue in 2021?
On one hand, there are catalysts that could propel the market higher. President-elect Joe Biden, who'll be sworn in on Jan. 20, has pledged to fight for additional fiscal stimulus. Meanwhile, the Federal Reserve is expected to keep lending rates at or near historic lows through at least 2023. The U.S. economy will be propped up in a variety ways, which would, presumably, be conducive to additional upside in equities.
On the other hand, history suggests we're in trouble.
Expect another volatile year in 2021
Over the past 71 years, the benchmark S&P 500 has undergone 38 stock market corrections of at least 10%. Nine of these moves lower resulted in a bear market (a loss of 20% or greater). On average, we see a bona fide correction every 1.87 years, with moves lower in the market of 5% to 9.9% happening with even greater frequency.
Further, in each of the previous eight bear markets (not including the COVID-19 bear market), there were an aggregate of 13 crashes or corrections of at least 10% within three years of hitting the bottom. This is to say that the typical bounce from a bear market low features one or two often abrupt crashes in the stock market of up to 19.9% .
Aside from history, other factors could play a role in weakening equities in 2021. For example, COVID-19 vaccines are fully expected to help lead the U.S. and world out of this pandemic. But there's no guarantee that clinical trials, regulatory approvals, production, distribution, and inoculations will go according to plan. At this point, we don't even know how many people are willing to get the vaccine in the U.S. or how long these prospective vaccines will provide protection.
Financial stocks, which are the backbone of the U.S. economy, could also struggle if additional state-level lockdowns or perhaps federal government-imposed shutdowns are ordered. Banks have done a generally good job of setting aside loan-loss reserves to this point but could be in for a dramatic uptick in loan delinquencies in 2021.
The point is, stock market crashes are an inevitable part of the investing cycle, and investors should be prepared for the worst in 2021.
The worst moves you can make if the stock market tanks
Of course, there are smart ways to navigate a stock market crash and a trio of moves that are the absolute worst things you can do. If the market does crash in 2021, avoid falling into these traps.
1. Panic-selling into short-term weakness
The first major mistake to avoid would be panic-selling one or more of your stocks because short-term momentum is picking up to the downside.
Though stock market crashes and corrections are unpredictable, one thing that's pretty well-known is that downside moves in the market usually don't last very long. Of those aforementioned 38 stock market corrections since the beginning of 1950, 24 have lasted between 13 and 104 calendar days (roughly 2 weeks to 3.5 months). Comparatively, bull markets are almost always measured in years, as opposed to weeks or months.
What's more, crashes and corrections are unlikely to have any bearing on your investment thesis in a company. If you were to take a step back and evaluate your initial reasons for buying into a stock, you'd see that a short-term crash or correction rarely, if ever, modifies that thesis.
In short, avoid running for the exit when volatility picks up.
2. Using margin to buy stocks
Secondly, you'll want to avoid using margin like the plague.
Even though history has shown time and again that high-quality companies tend to rise in value over time, it's impossible to predict short-term movements in the market. While buying on margin can magnify your gains, it can also compound your losses if you guess incorrectly in the short run.
To make matters worse, utilizing margin means borrowing money from your broker, with interest. Though the rate you'll owe can vary, you'll pay anywhere from the mid-1% range to the high-7% range when borrowing on margin from an online broker. The interest you'll owe is just added pain if you make the wrong move in the short term.
With the exception of short-selling, which should only be employed by tenured investors with an understanding of the risks involved, margin shouldn't be used.
3. Waiting for the market to bottom before buying stocks
The third and final action to avoid is waiting too long to buy stocks during a correction.
Speaking from experience, I can say that it's perfectly normal to want the best purchase price possible when buying a stake in a public company. Unfortunately, we're never going to know ahead of time when a crash will occur, how long it'll last, and how steep the move lower will be. That makes it impossible for investors to accurately time their purchases at the market bottom. I know I've missed out on a number of great companies because I figured they'd drop another 2%, 5%, or 10%, only to see them miss my purchase price and bounce 100%+.
Additionally, around half of the S&P 500's top-performing days over the trailing 20-year period have occurred within a couple of weeks of its worst single-session declines. If you decide not to buy on big down days in the market, there's a pretty good chance you'll miss out on the inevitable rebound.