Investment manager Ben Carlson wrote a great blog post a few days ago titled “To Win You Have to be Willing to Lose.”
The post contained a brilliant chart which showed the worst peak-to-trough losses (also known as drawdowns) that the S&P 500, a broad market index in the U.S, had experienced in each calendar year since 1950.
It also gave me the idea to recreate a similar chart for Singapore’s stock market using the Straits Times Index (SGX: ^STI) for the simple but important reason that such historical information can be very useful in helping investors understand the past so as to gain better context for what to expect in the future.
Before I share the results for the worst drawdowns that Singapore’s market barometer has had over the past 21 years (I only have complete data for the index from 1993 to 2014), here’s an important bit of information which you have to know and which I’d come back to shortly:
From the start of 1993 to the end of 2014, the Straits Times Index has more than doubled from 1,531 points to 3,365 points. That works out to an annualised return of only 3.8%. But if dividends are included, that can reasonably bump up the total annual return to around 6.8%, which isn’t too shabby at all.
With that, here’s the chart that’s inspired by Carlson (click for a larger image):
Source: S&P Capital IQ
For the timeframe we’re looking at, it’s remarkable to see that the Straits Times Index had gone through agonising double-digit drawdowns most of the time. In fact, there were only three calendar years when Singapore’s market benchmark had experienced a peak-to-trough loss of less than 10%.
Observers who have no inkling of how Singapore’s stock market has performed over the long-term will likely think that stocks here stink given how huge short-term losses are something that has happened in practically every year. But yet, like I mentioned earlier, the Straits Times Index has more than doubled in price from 1993 to 2014 and would have delivered a total return of nearly 7% if dividends were included.
Thing is, painful short-term losses are normal. It’s something that needs to happen in order for investors to enjoy long-term gains. Here’s Carlson with a good point in the same blog post of his I referenced earlier:
“Losses are a normal part of a well-functioning market. Without occasional losses, stocks wouldn’t earn a risk premium over safer asset classes such as bonds and cash.”
This echoes thoughts that my colleague Morgan Housel had when he described the theories of the late economist Hyman Minsky:
“Whether it’s stocks not crashing or the economy going a long time without a recessions, stability makes people feel safe. And when people feel safe, they take more risk, like going into debt or buying more stocks.
It pretty much has to be this way. If there was no volatility, and we knew stocks went up 8% every year [the long-run average annual return for the U.S. stock market], the only rational response would be to pay more for them, until they were expensive enough to return less than 8%.
It would be crazy for this not to happen, because no rational person would hold cash in the bank if they were guaranteed a higher return in stocks. If we had a 100% guarantee that stocks would return 8% a year, people would bid prices up until they returned the same amount as FDIC-insured savings accounts, which is about 0%.
But there are no guarantees — only the perception of guarantees. Bad stuff happens, and when stocks are priced for perfection, a mere sniff of bad news will send them plunging.”
Put another way, if there’s a widely-held perception that stocks won’t fall, market participants will be bidding them up to a level that will eventually cause risk to come home to roost.
A Fool’s take
As we’ve seen, short-term losses happen all the time. And having a rough guide for how often stocks suffer painful short-term drawdowns while posting respectable long-term gains can go a long way in helping investors develop the tenacity and mental fortitude needed to invest for the long-term.
The next time stocks fall hard in any given year, look at the chart above and remind yourself that it’s all just par for the course.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.