U.S. Equity Returns After Major Market Crashes

Leonard, Scott A.
October 2009
Journal of Financial Planning;Oct2009, Vol. 22 Issue 10, p84
Academic Journal
•Research shows that, on average, during periods of business cycle downturns, the expected equity risk premiums increase above the long-term average risk premiums. •This paper examines the recovery of the U.S. market after extreme downturns and evaluates whether they follow the historical average results. Additionally, this paper seeks to observe the magnitude of the risk premiums during a recovery as an indication of the possible length of time it took for equities to recover after a market crash. •This report analyzes the returns of the four major U.S. equity asset classes (large cap stocks, large cap value stocks, micro cap stocks, and small cap value stocks) during the 12-, 36-, and 60-month periods immediately after each major bear market. Based on this analysis, we can answer the question, "What equity asset class had the best returns after a major market crash?" •Using the S&P 500 Index, and going back to January 1926, there have been 23 separate bear and bull markets. The average bear market lasted I I months, while the average bull market lasted 32 months. Bull and bear markets are defined in hindsight, using cumulative monthly returns. •Our analysis found that risk premiums are above average in periods of extreme bear markets. Additionally, the research shows that the asset class risk premiums of micro cap and small cap value stocks exceeded their average bear market expected returns by a magnitude much greater than anticipated. •We determined that in the historical periods observed, a well diversified portfolio would fully recover to pre-market crash levels in three to five years, with the main factor being the amount of allocation to small cap stocks.


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