If you’re an investor who was stunned by Friday’s 4.6 percent drop in the Dow Jones industrial average, economic history can put the fall in perspective. And it even can supply a good news-bad news joke.
The perspective is that stock markets have had single-day drops of 5 percent or more repeatedly in living memory. Not quite 15 years ago, on October 19, 1987, the Dow fell 22.6 percent. Moreover, that plunge was not preceded by a roaring bull market, such as the one we have seen in the past five years.
The older generation may remember the months of successive bad days beginning in late October 1929. Starting with a 6 percent drop on Oct. 23, the New York stock exchange racked up eight days that were worse than yesterday in the 15 trading days leading up to Nov. 13, 1929.
In those three weeks, the Dow fell 35 percent compared with the 12 percent or so thus far in July 2002. That is about the same as the 34 percent decline in the 10 business days ending October 19, 1987.
The lesson of history is very simple: Drops happen. The good news is that prices have always recovered from even the most violent drops.
People who owned shares prior to the crash of 1929 or the deep knee bend of 1987 and hung on to them, eventually saw their shares return to their pre-plummet value. Another more recent example would be the months following Sept. 11, 2001. The Dow dropped to about 8,000 immediately after the attack on the World Trade Center but was back near 11,000 six months later.
The bad news is that bouncing back often takes a long time. The quick initial increase after Sept. 11 was an unprecedented recovery for an unprecedented political shock. But when share prices collapsed in 1929, it took nearly 30 years for them to regain the value they had had at their high in 1928. This covered four presidencies, from Hoover through Roosevelt, Truman and the first term of Dwight Eisenhower.
If one adjusts for inflation, recovery from 1929 did not occur until the Johnson administration.
Following the spectacular drops in October 1987, it took 21 months for prices to return to pre-drop levels. This was a very abbreviated drop and recovery — the low point reached on Oct. 19 was only two weeks after a new high set on October 5. Prices began to recover almost immediately, but it was not till July 31, 1989, that the Dow surpassed the mark set on Oct. 5, 1987.
The lesson: If you have ridden the market down this far, you can count on being able to ride it back up again unless you are already of retirement age. In that case, historical precedent is mixed. If we follow the 1987 pattern, there may be two or three lean years, but the longer run should be OK.
But if the pattern is more like the 1930s, retirees should accept that they will have a less affluent retirement than they had anticipated only 18 months ago.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.