How Common Is A Stock Market Crash?

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How Common Is A Stock Market Crash?

A crash is defined as an index dropping at least 50% from some previous high.

Smaller drops in the market between 20% and 50% are called “Bear Markets.” Larger drops of at least 80% are called “Depressions.”

The S&P 500 Price Index is the most common representation of “the market” when measuring market-wide corrections.

Since 1950, there has been exactly 1 stock market crash in the S&P 500 Price Index.

During that crash, the index spent just 21 trading days down more than 50% from its prior peak.

The Financial Crisis of 2007-2008

On 11/20/2008, the S&P 500 was at 752.44, down -51.93% from its previous high on 10/9/2007 at 1,565.15. The following day, the markets rose and the S&P 500 was down less than 50% from its prior peak until 2/19/2009 when the S&P 500 was at 778.94, down -50.23%. By then the markets had been dropping for 499 days or 1.4 years.

At that point, the market dropped for just 29 calendar days until it reached the bottom on 3/9/2009 at a value of 676.53 (down -56.78%) and began turning around. It recovered to its former peak on 03/28/2013.

The cycle of crash and full recovery took 1,997 days or 5.5 years.

While the the Financial Crisis of 2007-2008 is the only time since 1950 when the S&P 500 close was down over -50% from a previous peak, other events have come close enough to being called a stock market crash to make them worthy of being mentioned.

The Technology Bubble of 2000-2002

Toward the end of the Dot Com Technology Bubble, the S&P 500 Price Index bottomed on 10/9/2002, down -49.15% from its previous high on 3/24/2000.

While large cap growth technology stocks dropped more than 50% during the Bear Market, the S&P 500 did not. In fact, during 2000-2002 the Russell 2000 Value Index (small-cap value) appreciated 24.05% or 7.45% annually. During the Technology Bubble, diversification helped dampen the volatility from the technology sector.

The Flash Crash of 2010

After investors and their advisors experienced the precipitous market drop during the fall of 2008, many people searched for ways to protect their assets.

We rejected a strategy to hedge against a precipitous market drop called a stop-loss order which other advisors used. After purchasing a stock or exchange-traded fund (ETF), an investor can place an additional order with instructions on when to stop holding the security and sell it. Stop orders are triggered when the security reaches a specific price.

These limit orders started a cascade of selling on May 6, 2010. Market officials had wrongly put in rules which caused market makers to back away from the markets. If you know how a market is made,  you can predict that with no market makers prices are undefined. When there are more sellers than buyers, stock prices temporarily drop to zero. Unfortunately with automatic sells generated by stop loss orders, many investors simply sold their shares for nothing.

By the end of the day stock prices had returned to normal.

This event is one example of why we wrote that attempts to hedge against losses are misguided. It would have been better to put in a limit order to buy when stock prices fell!

Conclusion

While they do happen, market crashes are unlikely. Crashes in smaller indexes or sectors are more common than large ones like the S&P 500 because smaller indexes are more volatile.

We are liable to experience another general market crash in the next 50 years as well as some in smaller indexes and sectors. But as bad as the Financial Crisis of 2007-2008 was, we are completely over it now. Remain calm and rebalance your portfolio. If you treat the crash just like any other day, when you rebalance, you will naturally buy into what has gone down and sell whatever has gone up, making the most of a volatile market.

Photo used here under Flickr Creative Commons.

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David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818…)