After deep sell-offs, follow sharp rallies?
Posted on: February 4, 2008
In the three month period between Oct 19th, 2007 and Jan 18th, 2008, the S&P 500 index fell 14.1% and the Russell 2000 Value Index fell 19.5%. To understand what is likely to happen next, I studied the top 10 worst three-month-sell-offs since 1950. These sell-offs ranged between -13% to -30%. I found that in 8 out of the 10 occasions, the S&P 500 index rebounded by more than 20% in one year. Small Cap Value stocks did even better. The Fama & French Small Cap Value Index rallied more than 30% in one year in 8 out of the 10 occasions. In the other two occasions, it increased 6.6% and 24.1% respectively. (See Table below.)
A market sell-off is not a risk
As Demonstrated by history, most of the worst market sell-offs were followed by a substantial rally within a year. Many investors panicked and fled to cash at the nadirs of the sell-offs. By the time they mustered enough courage to get back in, they had missed the rallies. If you want to achieve long-term investment success, treat a market sell-off as an opportunity, instead of a risk.
Table: One-year returns after the worst 3-month sell-offs
| 3-month period ending | 3-month decline | Subsequent S&P 500 12-month return |
Subsequent Small Value 12-month return |
| Nov 1987 | -30% | 23% | 32.7% |
| Sep 1974 | -25% | 38% | 42.4% |
| Jun 1962 | -21% | 31% | 37.9% |
| Jun 1970 | -18% | 42% | 55.4% |
| Sep 2002 | -17% | 24% | 41.4% |
| Sep 2001 | -15% | -20% | 6.6% |
| May 1962 | -14% | 23% | 30.6% |
| Oct 1990 | -14% | 34% | 49.6% |
| Oct 1957 | -13% | 30% | 50.5% |
| Nov 2000 | -13% | -12% | 24.1% |
Data sources: Fidelity MARE group, Prof. Kenneth French data library.
The Investment Scientist 
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