Hello again, Power Profit Traders!
The S&P 500 may have dropped 25% off its high this year, but, even if it drops more, you have the ability to recover losses if you’re willing to think like an institutional investor instead of a nervous retail investor.
History will inevitably repeat itself when it comes to portfolio recovery. After every recession in the market’s history, the market has eventually bounced back and fully recovered losses.
The big question, however, is how long will it take, and can I handle the recovery time?
There’s no telling how far the market will drop before it begins a new, bullish run.
The recession of ’57 saw a 15% market decline. In 1974 the market lost nearly 30%, and you likely haven’t forgotten the near 40% decline we experienced in 2008.
In the case of every recession, the market has always eventually found higher ground.
Here’s the reality, however.
No matter how much the market falls, it takes a greater percent increase in the market just to get you back to break even because prices are lower.
If you’re willing to put your fears aside, and look at downturns as an opportunity, it’s possible to recover portfolio losses sooner than later.
The deeper a market declines, the higher the probability becomes it’s nearing a bottom.
Since World-War II we have experienced several recessions, and over the 77-year period the market has lost anywhere from 3% to nearly 40% of its value when looking at the year the recession was identified. In some years where recessions are officially announced, the market turned positive by year end.
Although there’s no way to tell how deep and wide a recession might be, as we look back at recessions over the decades, we can see that extreme, long-lasting declines are a-typical.
If we were to put the year-end losses on a scale, we’d notice that our current 25% market decline is only 15% away from matching the decline that occurred during 2008.
Obviously, the market can drop lower than 40%, especially when we include declines occurring before recessions are announced. From a historical perspective, the odds are that we’re getting closer to a market bottom than we are a new market high.
This tells us we’re already at extreme levels.
Well, you say, I’ve already lost 25% of my portfolio from the current market’s high this year, so it must be too late.
Quite the contrary – our current market scenario is screaming opportunity whether you went to cash earlier on, or you’re still fully invested!
The road to recovery, however, is likely to be a tough one as the market sinks to lower levels. Let’s take a look at how hard it is for investment portfolios to recover after a major tumble.
The market has to work harder to get your portfolio back to break even after a major decline.
It’s not something we put a lot of thought into, but after a market declines the portfolio value is lower, of course. As you look at the graphic below, you can see that a $100,000 portfolio is only worth $70,000 after a 30% selloff.
With the portfolio now only worth $70,000, it will require a 43% market increase off the low to restore the portfolio to its original market value even though the market only fell 30%.
Typically, the deeper the market’s decline, the longer the recovery period will be.
I mentioned above that historically the market has always recovered portfolio values as long as you wait out time.
There is another way to recover losses.
Investing on the way down can lead to quicker and better returns on the way up!
The idea is similar to reinvesting dividends or dollar-cost averaging investing.
As you look at the table below, you will see that the portfolio lost $38,700 of its value as the S&P fell 38.7% over time.
Now that the market value has fallen substantially, the market will have to rise 64% in order for the portfolio to fully recover its $100,000 previous value.
The illustration can help us understand why it usually takes much longer for portfolios to recover after drastic market declines.
And don’t forget, the portfolio hasn’t gained any ground concerning returns. It’s simply back to where it was before the fall. This means over the 18-month period of decline and recovery, the portfolio return was zero – your investment gained nothing.
Let’s next consider how adding new investments in a declining market can help recover your market value with less work, and result in positive returns.
In the table above, the portfolio was originally valued at $100,000 prior to the 38.7% market decline, but by adding to the investment as the market was in a chaotic downturn, the market decline and recovery results are impressive.
If the market took 18 months between declining and recovering, the additional investments led to a 17% POSITIVE RETURN in the end.
It’s a matter of mind set. You’ve likely experienced recessions before and watched in horror as portfolio values diminished, only to watch it take months and years to recover.
Sharply declining markets can cause emotional paralysis, and some of you won’t even bother opening your statements.
But once you recognize the opportunities that await by adding to the investments, instead of running from them, you’ll never look at this gift horse in the mouth again!
Until next time,
Tom Gentile
America’s #1 Pattern Trader
Join Tom each Monday through Wednesday at 12:00 p.m. ET as he discusses a range of strategies to make money in a strained market environment.
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