Saturday, March 10, 2012

How low can the stock market go?

At the Bogleheads Forum, I see they are playing around with the idea of how far the stock market can drop. Thank you to Taylor Larimore of Bogleheads for starting a thread about this issue.

Since I have some international data on this, I thought I'd have a look.

This is annual data from the Dimson, Marsh, Staunton Global Returns Dataset. The drawdowns from peak to trough may be even bigger with monthly data, but the best I can do is to look at annual data. These numbers are also the inflation-adjusted returns, which I find more interesting.  This is total returns data, which includes reinvested dividends. WWI and WWII account for some, but not all, of these outcomes. What I am listing is country name, years (beginning of the first year to end of the second year), and the percentage drop in real terms for the stock market...

Australia 1970-74  -66%
Belgium   1929-34  -65%
          1942-48  -79%
Finland   1917-21  -85%
          1943-48  -74%
          1989-91  -60%
France    1943-50  -88%
Germany   1914-31  -84%
          1948     -91%
Ireland   2007-08  -75%
Italy     1913-21  -68%
          1944-45  -85%
          1974-77  -75%
Japan     1946     -86%
          1940-47  -98%
          1990-02  -70%
N Zealand 1987-90  -73%
Norway    1917-21  -74%
          1973-78  -73%
Spain     1936-50  -56%
          1974-82  -84%
Switzerland 1915-1921 -73%
US        1929-31  -60%
UK        1973-74  -71%

I am only looking at the 19 developed market countries in the dataset, with data going back to 1900. But if you went back to 1900 and tried to put together a list of "developed markets" for the 20th century, you might have included Argentina, Russia, China, etc. As those countries never made the dataset, even these results have some "survivorship bias" in them.

While I have noted that it is rather expensive to build a relatively safe TIPS bond ladder for retirement when interest rates are low, the results I am showing here do help to highlight that stock markets are risky and that time diversification is no panacea for investors.


  1. Wow. Japan '90-'02 sure puts a new perspective on American complaints about a "lost decade".

    Making the point with monthly data would just be the equivalent of switching from a sledgehammer to a jackhammer...

  2. here is the missing link to that bogleheads forum!

    - s.b. (a member of bogleheads)

  3. The International data is a great set to present, but conversely the BULL markets should be given their due. While investors often gauge their failures from the high water mark of their portfolios, this is dream-chasing few can limit risks when the bull party is ending.
    Portfolio 'drawdown' is still very important as the data suggests, as that drives investor behaviour to often SELL out near the bottom and de-rail their chance of recovering.
    Good work none-the-less.
    Barry Unterbrink, Chartered Retirement Planning Counselor

  4. Thank you all three for the comments.

    s.b. I've linked to Bogleheads many times, but thanks for pointing out that in haste I missed the link this time. Also, you've got a link embedded into the comments. I didn't know that was possible. I need to figure out how you did that.

    Barry, thank you. I was thinking in particular that when one retires at the start of a bear market, it can be a big problem. I should note that some of these drawdowns were preceded or followed by some rather large stock returns, which would help during accumulation but be less helpful in retirement. You might see:

    for more about this.

    (That's still the only way I know how to add links in comments)

  5. If you have access to such data it might be interesting to put together the same table for a whole-world stock portfolio (all investable markets at their respective weights) and look at worst drawdowns there. Just to see how much "protection" was obtained by diversifying internationally.

    Probably would look significantly less scary, with the exception of the Great Depression.

    1. Thanks a good idea.

      I do have a GDP-weighted world portfolio for the 19 countries in the dataset. This is converted into US dollars.

      The biggest drawdowns for the world portfolio were:

      1913-20 -52%
      1929-31 -53%
      1942-47 -30%
      1973-74 -47%
      2000-02 -44%
      2008 -40%

    2. Thanks! Surprising that the Great Depression doesn't stand out that much compared to other bad times. Great work putting this together, as always.

    3. Thank you Wade for these world calculations. Indeed these are sobering numbers, though they're not as horrible as the individual country results you showed above. I view these world drawdown numbers as a clear demonstration of a benefit of wide international diversification.

      Best wishes,

      Steve Thorpe

  6. Wasn't there also something like a -25% deflation over the Great Depression? So a -37% decline in real terms. Which was less of a down than 2008 when stocks lost -38% real.

    1. Clive,

      The -60% for the US was already in real terms. The drop would be bigger in nominal terms.

      I wrote this at Bogleheads:

      Now I am looking at the SBBI monthly data for the US, total returns on the S&P 500.

      From Sept. 1929 to June 1932, the nominal drop was 83%, and the price level dropped by 21%. In inflation-adjusted terms, I'm calculating -79% by converting monthly nominal data into monthly real data and repeating the calculation.

      I think your formula might be a bit off, you can't use the simple i = r + infl

      when r and infl are big. that is just an approximation that works well when r and infl are small.

      the full formula is is

      i = r + infl + r * infl

  7. Wade,

    To embed a link in a comment, do this:

    left chevron character (<), then a href="the URL you want to link to", right chevron character (>), then the word or words you want to appear as hypertext, then left chevron (<), forward slash (/), then the letter a, then the right chevron character (>).

    It isn't possible to actually do this in this comment, because it appears as a linked word, so I have to write it out. If you still have a problem or don't understand, search on embed link html and you should find specific instructions on a web page.

    Pay attention to the letter a, the quotation marks, and the chevron characters. Don't leave any characters out or it won't work. Computers are really picky!

    1. Thanks! The blog comments use standard HTML. I've got it.

    2. Thanks, this is a good and valuable post. Commodity Exchange

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