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Norman Rothery, PhD, CFA, is the founder of

Halloween is near at hand and the spectre of a bear market stalks the land. It’s shaping up to be a thriller for investors.

But the graveyards of the past provide a dose of solace for those who fear that the clammy hand of death will descend on their portfolios.

To investigate the situation I turned to the market database maintained by Professor Kenneth French, who slices the market up in the most entertaining of ways.

Today, I’ll stick to sorting stocks by size in an effort to track a proxy for the U.S. stock market. In this case, a market portfolio that follows the largest 30 per cent of U.S. stocks (by market capitalization) from the middle of 1926 to the end of August, 2018, using monthly data.

The long record provides a glimpse of the times before the modern incarnation of the S&P 500, which was launched in 1957. The market portfolio is similar to the S&P 500 in that it currently tracks 526 of the largest stocks in the land and it is weighted by market capitalization.

As you might expect, the U.S. stock market fared well over the very long term with average annual total returns of 9.9 per cent. Such generous returns are hardly the stuff of nightmares, but they include sickening plunges and terrifying crashes along the way.

I used a two-step process to highlight the bad times. First, I tracked the market portfolio over the years and noted its highest point as the months went by. I then calculated how far it had fallen as a fraction of its prior peak.

For instance, the biggest market crash occurred after the market hit a peak in 1929 and tumbled to a low in 1932 in a catastrophe that helped spawn the Great Depression of the 1930s. The market portfolio fell to just 17 per cent of its prior peak – a plunge of 83 per cent.

Problem is, a gain of 83 per cent after a plunge of 83 per cent doesn’t get you back to break-even. The crash turned each dollar invested into 17 cents. An 83-per-cent gain on 17 cents gets you back to just 31 cents.

Instead, to recover from an 83-per-cent loss, one needs a 489-per-cent gain.

Nonetheless, the market portfolio eventually recovered and exceeded its 1929 highs in 1945. (Here I’m focusing on nominal, rather than inflation-adjusted, total returns.) The great bear market prompted many investors to avoid stocks like the plague for decades and to view the stock market as a playground for charlatans and gamblers. Some would say it hasn’t changed all that much.

The accompanying graph highlights the bear markets and corrections of the past 92 years.

While the 1929 crash was the worst of the bunch, declines in excess of 40 per cent occurred after peaks in 1973, 2000 and 2007. The last one saw the stock market fall almost 50 per cent from its highs.

While the two big crashes of this century scared many out of the markets, investors became enthusiastic again as the markets recovered and moved to new highs in recent months. Money manager Benjamin Graham’s fictional Mr. Market – much like a money-grubbing version of Dr. Jekyll – was still in a manically exuberant phase until the cool weather of October. Now, Mr. Market appears to be becoming despondent once again.

The S&P 500 peaked in September at 2,941 and tumbled to a low of 2,652 this Wednesday. The index was down almost 10 per cent from its prior peak – a decline that would qualify it as a correction.

But, as frightening as it might be, a 10-per-cent decline would be a tiny blip in the historical record. So, enjoy the season of ghosts and goblins while you can because the market might be brewing up something really scary.

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