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What Does the Stock Market Do After Record Down Quarters?

Source: Marketwatch

At ZEGA we don’t make year end market predictions. Instead as most of you know we are proponents of using a core hedged or buffered equity strategy. We recently made the point that if markets go up great, our Buy and Hedge Strategy clients participate in the majority of the upside but have a defined equity portion downside. 

If markets move lower, your clients will feel the first 8% to 10% down but avoid equity losses beyond that point. If markets selloff 50%, the theory is this becomes an opportunity to reinvest at much lower levels into more shares having missed 40% of the decline. As we highlight a recent Marketwatch piece, its important to note that history is just that. What HAS happened, not what will happen. Using hedged equity provides a solution to prepare for whatever comes next. 

While 2018’s 4th quarter isn’t over quite yet, many investors are ready to be done with a year that saw record highs followed by a steep downturn to end the year. While we don’t make year end predictions or forecasts, we found this article an interesting read.  In it Marketwatch looked back at performance following the worst quarters for stocks, one, three, and five years afterwards. 

As the article states, we’re currently in the 14th worst performing quarter looking back to 1926. With the exception of the Great Depression years, the S&P 500 has moved higher in all periods listed following these quarters of strong declines. 

Below, we can see an example from the Russell 2000 Index since 1979 (when it was created). If markets end the year in the Russell where they are now, it would log the third or fourth worst quarter ever. Aside from the September 2001 quarter which returned a -9% one year after, all others were positive including the 3-year post and 5-year post on that September 2001 quarter. 

We’ll keep this post-Christmas post short, but we thought some perspective brought out by the article would help give some historical context to what we are seeing at the end of 2018. As we mentioned earlier, we don’t make predictions and our strategies are not designed based on opinion. Instead we remain disciplined and use a rules-based approach. This includes building in hedges and buffers should markets like this happen.