Morningstar - Q3 2022 - 40

Strategies
Once Again, the Stock Market Drops a Lot
Equity investing can be rewarding, but
the risks must be understood.
Research
44
Spending Shifts Back to Services
Quant U
48 Immediate Variable Annuities:
Real and Imagined
Best Ideas
53 Manager: Go Anywhere
54 Passive: Striking the Right Balance
55
Equity: Downturn Creates a Rare Deal
RESEARCH
Paul D. Kaplan
Here we go again.
From December 2021 through June 2022, as
I measure it for this article, the U.S. equity market
was down 24.7% in real terms.
This is not the first article I've written about large
stock market declines. In 2009, I co-wrote a
chapter of the CFA Institute Research Foundation's
Insights Into the Global Financial Crisis. In that
chapter, my co-authors and I looked at the
history of stock market crashes from January 1871
to June 2009. While doing research for that
chapter, I wrote an article on the history of market
crashes for Morningstar Advisor magazine
titled " Déjù Vu All Over Again " (February/March
2009). I wrote four more articles for various
Morningstar publications about market crashes.
I then collected these five articles into a
section on crashes in my 2012 book, Frontiers
of Modern Asset Allocation.1
Fast forward to early 2020 when the COVID-19
pandemic struck. At first, there was a large
market decline; the U.S. stock market fell 18.3% in
real terms from January 2020 through March
2020. At that time, I wrote the article " Black
Turkeys Everywhere " (Morningstar Q2 2020) to put
that decline in historical perspective using
the same data going back to 1871 that I used in
my previous articles. (I used black turkeys
as a play on black swans to indicate that bear
markets are not as rare as they may seem.)
Fortunately, that downturn was short-lived;
the market returned to its January level by July.
So, I updated the " Black Turkeys " article
and called it " The Turkey That Didn't Gobble "
(Morningstar Q2 2021).
In all of these market-crash articles I've written,
several themes emerge:
gFrom time to time, stock markets go through long
and deep periods of decline.
gAfter a large decline, it is hard to predict how
long it will take for stock markets to recover.
gOver the very long run, stock markets have been
very generous to investors who can get through
long periods of decline.
gDuring times of a rapid and deep decline,
investors should avoid panic selling.
gThe standard bell curve is an inadequate model
of stock market returns. A model that can
capture the extreme risks of the equity market
(its fat tails) is needed.
gSometimes, the market and economy move in
opposite directions.
An investor who stayed in the market through
these extreme downturns has been well
rewarded so far. At the time that I wrote " Déjù Vu
All Over Again, " the market had bottomed
out in February 2009. From then through June
2022, it was up 379%. At the time that I
wrote " Black Turkeys Everywhere, " the market
1 Kaplan. Paul D., ed. 2012. Frontiers of Modern Asset Allocation. John Wiley & Sons. Chapters 16-20.
40
Morningstar Q3 2022

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