As I recently discussed, from an emotional perspective, steep market declines are difficult to deal with. The reason is we tend to feel the pain of a loss twice as much as we feel the joy from an equal-sized gain (the ratio increases with the size of the investment).
Research also has found that losses even lead to physical responses, such as pupil dilation and increased heart rate. This has been found to be true even for people who weren’t naturally averse to losses.
With the S&P 500 Index losing 13.5% in the fourth quarter of 2018, the risk of catastrophizing—not only focusing solely on the negative news, but assuming the worst will occur—increased.
Reviewing the historical data, however, just might help to keep you from catastrophizing your own financial situation. For instance, the following table shows each quarter the S&P 500 Index turned in a performance equal to or worse than the fourth quarter of 2018. Data is from Bloomberg.
There were five cases when the next quarter’s return was negative, three of which saw losses in excess of 10%; but there were 16 cases when the following quarter’s returns were positive, seven of which were in double digits. The average return in following quarters was 12.7%. In addition, the average following 12-month returns, at 22%, were more than twice the historical return of about 10%.
Here are some other facts that might keep you from catastrophizing. The last two big bear markets began in March 2000 and October 2007. The following table, using data from J.P. Morgan Asset Management’s first quarter 2019 “Guide to the Markets,” compares valuations for the S&P 500 Index and the yield on the 10-year Treasury at those times to the corresponding figures at year-end 2018.
As you can see, valuations are now much lower than they were prior to the last bear markets. In addition, according to the J.P. Morgan Asset Management report, the 25-year average for the price-to-book (P/B) ratio for the S&P 500 has been 2.9. It’s now 2.7.