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BIG V…or little v?? Dr. Seuss and Stock Market Volatility   Part 2

BIG V…or little v?? Dr. Seuss and Stock Market Volatility Part 2

February 07, 2022
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In my last post, I shared something I learned as a child from the Dr. Seuss ABC book. The book gave rhyming examples of words that started with each letter of the alphabet, with both upper- and lower-case examples, as you can see below:

As a reminder, when we look at BIG V’s or little v’s here, the V in question refers to the shape stock market drops and recoveries looks like on a graph. Today, many people want to know how much more the stock market could drop and how long it might take to recover. Last time we focused on what happens in the stock market when we have little v events. These are defined by quick drops caused by economic or political shocks to the markets and the economy. However, they tend to be short-lived, and the markets move higher relatively quickly.

On the contrary, when we think about larger and longer downturns in the stock market, that took much longer to recover from, they were typically accompanied by significant recessions. An obvious example is the recession experienced during the dot.com, 9/11, Enron/WorldCom scenario that played out during calendar years 2000-2002. During this time, the markets dropped by more than 45%. It took nearly more than six years for the markets to reach new highs (See chart below).

Most of us also vividly remember the significant recession related to the housing and subprime mortgage bubble in 2007-2008. This not only took down large financial institutions such as AIG and Lehman Brothers, but it also prompted government bail outs of the banking system through the TARP program. All of this led to a stock market that dropped more than 50%. It took nearly five years to recover, as you can see in the chart below.

How do we compare these to the COVID-19, coronavirus induced recession and stock market drop that we experienced in February and March 2020? It is a little bit hard to put in perspective, as there is no parallel event in modern history. It was much more akin to a national natural disaster, in which economic activity was halted. This caused the fastest stock market drop that we have seen, as the market fell 34% in 19 trading days. This produced the shortest recession we have ever recorded, only two months long. An equally strong recovery was primarily the result of massive monetary and fiscal stimulus provided by the Federal Government and the Federal Reserve Bank.

Today, clients are asking the question, "should we be getting defensive?". That's the exact opposite of what historically successful investors, such as Warren Buffett, ask during times like these.  When stocks are up significantly, and we know that the long-run average return for stocks is around 10%, that's the time to harvest cash and reduce risk. 

When stocks are down 10-20%, it could be the time to start buying what is on sale. The reality is most investors should see declines in the U.S. stock market as an opportunity. Average investors CAN ask the same questions the best investors in the world do.

Now the BIGquestion that most people want to know the answer to: Are we going to have a bear market? The answer is certainly, but we don’t know when. And it makes a difference when it happens. History shows us that recessions lead to bigger and deeper V-shaped drops in the stock market that take much longer to recover from. So, it is important to know if we are in danger of one in the near future.

The team at Impel Wealth Management will continue to watch the signs. So far, we have not seen the typical contraction in the ISM indexes, a downturn in the index of Leading Economic Indicators, or the yield curve inverting. These are things that we will be paying attention to going forward. It is part of our mission as we continue to help guide our friends and clients through the ups and downs of the markets and the economy. It will also help us answer the question whether the next V will be a big one or a little one.  I would like to thank Dr. Seuss, who once again helps provide a framework for thinking through life’s questions.

As always, if you have any questions, please reach out to your advisor at Impel Wealth Management. If you find this topic share worthy, please feel free to share this with your friends and loved ones. Education and confidence are part of what we want to provide to you as we continue “Moving Life Forward”.

The views stated are not necessarily the opinion of Cetera Advisors LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein.  Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.  Past performance does not guarantee future results.