How Bad is It?

Updated: September 1, 2015

As I write at the market close Monday, September 15, Lehman Brothers is filing for bankruptcy, Bank of America has acquired Merrill Lynch, and large insurance holding company AIG is scrambling to raise capital. The market is down about 4.5%.

Through the end of July, the stock market had declined from its October 2007 peak by approximately 16%, using a very broad measure of market return. If you hold stocks, this was a very unpleasant nine months. One logical question is: “how bad is it?” In US stock market history, has it been this bad before? When, and what were the circumstances? Has it been worse?

All of these questions are intended to give us stock investors a sense of perspective on the market.

As we begin, it is important to remind ourselves that no one knows what will happen to the stock market from this day forward. The experts cannot agree on what will happen next in important sectors that seem to be influencing the stock market strongly these days (US housing, oil, credit), and no one knows the extent to which the stock market already has assessed the likely developments in these sectors, and factored those assessments into stock prices.

That is, we can gain perspective from the assessment we are about to undertake, but we cannot make predictions.

We’ve used a broad database of stock returns data, drawn by Kenneth French of the Tuck Business School at Dartmouth College from the Center for Research on Securities Prices (CRSP) at the University of Chicago. This database contains returns for all US common stocks traded on the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX) and the NASDAQ from 1926 to the present. The measure of “market” returns is the market value weighted average return of all of the stocks in the database. Conceptually, this is the same analysis performed by Standard & Poor’s (S&P) in constructing the S&P 500 index, but for the whole market rather than for the 500 large firms S&P selects.

We calculated returns for every nine month period starting with the nine months ending in March 1927 and concluding with the nine months ending July 2008. That’s 977 nine month periods in all. Approximately 7% of the nine month time periods had worse returns than the 3 quarters we’ve just been through.

If returns were distributed randomly through time, approximately one of every 14 nine month periods would be this bad or worse, and we’d expect one every 11 years or so.

The graph displays rolling nine month returns since 1927. We’ve truncated the display at positive and negative 40% so that we can see the detail better. Just a glance tells us that very few 9 month declines have been as large as the one we’re suffering through. We can also identify by eye the times that have been as bad or worse. The table below identifies when the decline occurred, the situation, and the peak to trough decline (that is, the decline from the market high point to the market low point before the next sustained increase).

9 Month Period Ending Situation 9 Month Decline Peak to Trough Decline Trough Date Discussion
October, 1929 through May, 1932 Beginning of the Great Depression 20% 84%
June, 1932
A series of declines interspersed with recoveries began in October, 1929. The market did not recover to its September, 1929 peak until 1944. However, the market recovered its June, 1926 level by June, 1933.
September, 1937 to May, 1938 Recession of 1937    
Viewed as part of the Great Depression by many observers
June, 1940 Outbreak of World War II 17% 17%
June, 1940
The evacuation of British troops from France at Dunkirk was completed June 4, 1940
April, 1942 WW II low point for US 23% 23%
April, 1942
Japan nearly completes conquest of Southeast Asia
February and April, 1947 Post World War II 18% 23%
April, 1947
No particular explanation available
June, 1962 Early 1960s 17% 23%
June, 1962
No particular explanation available
January & June, 1970 Penn Central Bankruptcy 22% 27%
June, 1970
Increase in commercial paper interest rates
June – December, 1974 OPEC oil price shock 22% 41%
June, 1970
Increase in commercial paper interest rates
November, 1987 Largest one day decline in US history (October 19) 20% 30%
Nov, 1987
Conclusion of a 3 year boom in stock prices (trough to peak increase was 130%)
March – December, 2001, September, 2002 Bursting of the technology bubble, terrorist attacks 22% 31%
Sep, 2002
The decline began in September 2000, followed by another sharp decline in November 2000. Successive falls in February and March 2000 brought the 9 month drop to 22%. After further declines spurred by the attacks on September 11, the market recovered in October and November before further steady declines ending in September 2002.
July, 2008 Sub-prime credit crisis 16% 16% (so far)
July, 2008 (so far)
First monthly decline was in November, 2007, and several months of decline have followed. Ongoing problems in various credit markets have contributed to the stock market’s decline. Official data for August are not yet available, but there is evidence the market was up slightly. So far in September, the market is down.

There are some bad market periods on this list – the recent decline is in some extreme company. In fact, many of them have been worse than the one we are experiencing now has been so far. Most recently, in terms of market decline, the bursting of the technology bubble in 2000-2002 was worse.

This is the kind of market downturn that we as stock investors must expect and factor into our investment decision-making. It is unusual (as we said above, only 7% of nine month periods are as bad or worse), but far from “the worst in living memory.”

So, will this decline continue to get worse, or will stock prices begin to improve soon? Unfortunately, there is no way to know. Stock prices could continue to go down, or they could begin to rise again.

We can take some comfort from our diversified approach. For example, while the financial company stocks have suffered most severely in this decline (down some 40% since the October peak), our exposure to them has been limited, and our stock portfolios, while they have declined, have declined far less.

As I did earlier in the year, I encourage you consider this decline as an opportunity to assess your comfort with stock investment risk. If your discomfort is high, please let me know, and we will adjust your allocation.

1. Dr. French kindly makes this data publicly available on his website at

2. You might ask whether the fact that the time periods overlap might somehow affect the analysis. There are 109 non-overlapping nine month periods since March 1927, and 5.5% of them have been worse than the most recent one. 5.5% is different than 7%, but not much different.

3. Using non-overlapping nine month periods, one in every 18 or so would be this bad, and we’d see one like this every 14 years or so.