The Investment Scientist

US Stock Performance after Deep Recessions

Posted on: April 12, 2011

US Stock Market Returns

US Stock Market Returns

What an indelible mark on many investors’ psyche the financial crisis in 2008 has left! Despite two years of strong equity returns, many investors are still on the sideline, afraid even to dip their toes into the market.

That’s understandable. Most investors’ perspectives are shaped by their most recent experiences. They are now doing things they wish they had done prior to the economy’s plunge into crisis. But does this make sense now that we are recovering?

Let’s look at two periods when investors had strong reasons for pessimism, and consider the parallels to today:

1932: The US stock market had just experienced four consecutive years of negative returns. A 1929 dollar invested in stocks was worth only 31 cents by the end of 1932. Hopes were sinking during the Great Depression, and many people felt as though the economy had permanently changed. Many investors left the market, and some would not return for a generation. Amidst what is considered the roughest economic time in US history, the markets looked ahead to recovery.

US Stock Market Performance after 1932*

5 Years       10 Years       20 Years

Annualized Return          15.35%           10.07%           13.19%

Growth of $1                     $2.04              $2.61             $11.92

*All stock market returns based on CRSP 1-10 Index.

1974: Investors had just experienced the worst two-year market decline since the early 1930s, and the economy was entering its second year of recession. The Middle East war had triggered the Arab oil embargo in late 1973, which drove crude oil prices to record levels and resulted in price controls and gas lines. Consumers feared that other shortages would develop. President Nixon resigned from office in August over the Watergate scandal. Annual inflation in 1974 averaged 11%, and with mortgage rates at 10%, the housing market was experiencing its worst slump in decades. With prices and unemployment rising, consumer confidence was weak and many economists were predicting another depression.

US Stock Market Performance after 1974

5 years          10 years        20 years

Annualized Return         17.29%              15.92%           14.89%

Growth of $1                    $2.22                 $4.38            $16.07

Keep in mind that the long-term average return of equity is about 10% (see the chart above).  In the two periods (prior to 2008) when the US economy was hit by a deep and lasting recession, the subsequent long-term returns of the stock market were elevated to 13% to 15%.

This evidence is consistent with the simple investment principle I advocate: when people are afraid to invest in stocks, the equity costs of capital for businesses are higher; therefore, the expected returns must be higher as well.  This doesn’t mean that a higher average return over the next 20 years is guaranteed, just that the odds are better following a deep recession.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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