After another volatile open on Tuesday, the SPDR S&P 500 ETF (NYSE: SPY) is down 15% overall in the past month due to fears over the coronavirus outbreak and Monday’s collapse in oil prices. Investors are reaching the critical point in the sell-off at which they need to determine whether the recent action is the beginning of the end of the 11-year-old bull market in stocks or yet another stock market correction that will be a distant memory in a matter of months.
DataTrek Research co-founder Nicholas Colas compared the recent market sell-off to previous market crashes in 1987, 2000 and 2008. The S&P 500 crashed 7.6% on Monday, its seventh worst single-day percentage decline in history. There were similar crashes in all three of the prior years mentioned, but the subsequent years played out very differently each time.
History Of Stock Market Crashes
October 1987 has three single-day crashes of at least 5%, including a 20% crash on Oct. 19, 1987. Looking back, Colas said buying the first 5% crash in 1987 would have cost investors another 10% loss over the following three months. However, by dollar cost averaging an overall position by buying the second and third 5% crashes would have resulted in a 12.4% overall gain by October 1988.
In 2000, there was only a single one-day crash of at least 5%, and buying the dip was a huge mistake. The S&P 500 dropped 5.8% on April 14, 2000 and dropped another 12.8% in the year that followed.
In 2008 and 2009, there were 11 days in which the S&P 500 dropped at least 5% in a single day. Buying the first 5% crash on Sept. 29, 2008, would have essentially produced no return a year later. By following the 1987 playbook and buying after the third 5% crash on Oct. 15, 2008, traders would have made a 9.3% gain over the following year.
How To Play The 2020 Stock Market Crash
The million dollar question for investors today is which year is the most appropriate comparison to the current situation: 1987, 2000 or 2009?
Colas said he thinks the financial crisis of 2008 and 2009 is the best comparison to today, suggesting a sharp, steep drop in stock prices followed by a quick recovery. Colas said the Federal Reserve has much less room for economic stimulus today than in 1987.
“That may sound extreme, but unless Russia and Saudi Arabia quickly reconcile oil prices point to deflation and COVID-19 still threatens the US/global economy with at least a short but sharp recession,” he said.
“If you have a +12 month time horizon and a strong ability to weather possible drawdowns, you buy the next 4 down +5% crash closes.”
For investors that have a lower near-term risk tolerance, Colas recommended staying on the sidelines during the first four 5% single-day crashes before starting to buy on the fifth and cost averaging by buying each subsequent 5% drop.
It’s extremely difficult for even the most accomplished traders to predict the direction of a volatile market in the short-term. The longer your investing horizon, the more predictable the market gets. Even investors who bought at the market top just prior to the 1987, 2000 and 2008 crashes ended up making big returns in the long-term if they simply held onto their positions and did not panic.
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