Morningstar - Q3 2022 - 42

Strategies
EXHIBIT 2
No Crash Is the Same As history shows, there is no way of knowing how severe a
crash will be, how long it will last, or how long it will take to recover.
Largest Inflation-Adjusted Declines in U.S. Stock Market History: January 1871-June 2022
Rank Peak
Trough
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
Aug 1929 May 1932
Aug 2000 Feb 2009
Sep 1974
Dec 1920
Decline
(%)
Recovery
79.0 Nov 1936
Dec 1972
Jun 1911
Feb 1937 Mar 1938
May 1946 Feb 1948
Nov 1968 Jun 1970
Oct 1907
Jun 1900
Jan 1906
Apr 1899
Aug 1987 Nov 1987
Oct 1892
Jul 1893
Dec 2021 Jun 2022
Jun 1962
Dec 1961
Nov 1886 Mar 1888
Sep 1903
Apr 1903
Aug 1897 Mar 1898
Sep 1909
Jul 1910
May 1890 Jul 1891
Jan 2020 Mar 2020
Jan 1966 Sep 1966
Dec 1957
Jul 1956
May 1990 Oct 1990
51.9
51.0
49.9
37.2
Jun 1983
Event
Crash of 1929, 1st
Part of Great Depression
57.6 Nov 2013 Lost Decade: Dot-Com Bubble, Global Financial Crisis
Inflationary Bear Market, Vietnam, Watergate
Dec 1924 WW I, Influenza Pandemic, Postwar Auto Bubble Burst
2nd
Feb 1945
Oct 1950
35.5 Nov 1972
Part of Great Depression, World War II
Postwar Bear Market
Start of Inflationary Bear Market
34.2 Aug 1908 Panic of 1907
30.4 Mar 1901 Cornering of Northern Pacific Stock
Black Monday-Oct. 19, 1987
Jul 1989
Ukraine, Inflation, Shortages
27.3 Mar 1894 Silver Agitation
24.7 TBD
22.8 Apr 1963 Height of Cold War, Cuban Missile Crisis
22.0 May 1889 Depression, Railroad Strikes
21.7 Nov 1904 Rich Man's Panic
21.1 Aug 1898
20.5
20.1
18.3
17.5
17.4
Feb 1911
Feb 1892
Jul 2020
18.0 Apr 1967
Sep 1958
Feb 1991
Outbreak of Boer War
Enforcement of the Sherman Anti-Trust Act
Baring Brothers Crisis
COVID-19 Pandemic
Fear of Recession
Anticipation of Recession
1st Gulf War, Mild Recession
Sources: See Kaplan, Paul D. 2021. " The Turkey That Didn't Gobble. " Morningstar, Q2, and footnote 2.
In summary, equity investing can be quite
rewarding, but the risks must be understood.
An examination of the historical records
helps us understand the risks and rewards
in ways that are missed by a bell curve
model. Understanding the historical record should
help investors get through the current market
downturn, and if this downturn is like all
the others in the past 150 years, investors will
be richly compensated. K
to recover. This recovery was short-lived, however.
It was followed by an almost 50% decline, the
fifth-largest decline on our list.
In more recent memory was the second-largest
decline of 57.6%, which occurred during the 2000s.
The Lost Decade started when the dot-com bubble
burst in early 2000. The market nearly recovered
years later, but it then experienced another crash,
this one caused by the global financial crisis.
To put things in even more perspective, note that
the decline of 18.3% that started with the COVID-19
pandemic (19th
on our list of worst crashes)
took only four months to recover, even though the
pandemic has lasted far longer. This shows
how the market can at times be disconnected from
the real world.
As of June 2022, the current decline stands
at 24.7% and is now 12th
on our list. We are in an
4 I discuss fat-tailed return distributions in " Fat Tails and a Gaggle of Economists " (Morningstar, Q2 2020) and in chapters 18, 19, and 20 in Frontiers of Modern Asset Allocation.
5 I plotted the distribution of the historical returns using the technique described in Appendix 26A in Frontiers of Modern Asset Allocation.
42
Morningstar Q3 2022
Paul D. Kaplan, Ph.D, CFA, is director of research with
Morningstar Canada. He is a member of the editorial board
of Morningstar magazine..
30.2
Fat-Tailed World
One reason that the risks and potential rewards of
equity investing are often misunderstood is
that standard models of equity returns are based
on the bell curve. In a bell curve model, it
is virtually impossible for there to be the sort of
extreme returns that are largely responsible
for the deep declines and large runups that we see
in EXHIBITS 1 and 2. In other words, bell curve
models lack the fat tails (the extreme returns
on the ends of the curve) that we see in historical
returns.4
official bear market. At this point, we don't know
how severe it will be, how long it will last,
or how long it will take to recover. But if history is
any guide, prudent long-term investors who
can withstand the risks of equity investing should
not panic and should stay the course.
If the bell curve distribution is plotted
against the actual distribution of real total returns
on stocks for the period January 1886 to June
2022, the two distributions would be quite different.5
The historical distribution would be much higher
than that of the bell curve model, and it is
also higher in the tails, especially on the downside.

Morningstar - Q3 2022

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