What history has taught us about buying the dip - Once in a decade entry opportunity
The first six months of 2022 might not have looked the most promising for investing in the stock market and have left many investors worried. However, it is important to remember that all hope has not been lost, and there is a silver lining we must notice.
Geopolitical and economic factors like the Ukraine-Russia war, aggressive interest rate hikes in the US, and high inflation rates have disrupted the market. As a result of these factors, panic selling, economic bubbles, and speculation amongst buyers and investors have caused stock market dips.
History has taught us that stock market crashes tend to occur amid the fallout of an economic crisis or due to major catastrophic events. Let’s look at some significant past market crashes and how the market has performed following the crash. This history lesson will serve as a guiding light for investors today.
Sept 2001 after the 9/11 attack
On September 11, 2001, the opening of the New York Stock Exchange (NYSE) was delayed following the first plane crash, and trading for the day was canceled after the second plane crashed into the World Trade Center’s North and South Towers, respectively. NASDAQ also canceled trading, and stock exchanges across the globe were closed for fear of further terrorist attacks. The NYSE remained closed until the following Monday.
Currency trading continued resulting in the United States dollar falling drastically against the British pound, Euro, and the Japanese Yen. The European stock markets and several other global stock markets also plunged to new lows. The first week of trading following the 9/11 attacks saw the S&P fall by more than 14%, whereas gold and oil prices spiked upwards.
However, as you can see from the graph below, the Dow Jones Industrial Average dropped once more following a brief spike following the 9/11 attacks and then continued to gradually recover from the drastic plunge that it endured as a result of the attacks.
Lehman bros 2009
The Federal National Mortgage Association (also known as the FNMA or Fannie Mae) attempted to make home loans more accessible to citizens in the United States, who had low credit ratings and less money to spend on down payments than what was typically required by lenders.
This led to the rise of subprime buyers, who were offered mortgages with payment terms like high-interest rates and variable payment schedules. This led to explosive growth in mortgage originations and home sales. Companies used this opportunity to capitalize on the surging housing economy by heavily indebting themselves.
The Lehman Brothers were one of the first firms on Wall Street to move into the mortgage business. By 2008, Lehman had transformed into a real estate hedge fund disguised as an investment banking firm. They had assets worth $680 billion but only $22.5 billion of firm capital. Lehman Brothers flourished by borrowing significant amounts to fund its investing, in a process known as leveraging or gearing.
In 2008, Lehman faced unprecedented losses due to the continuing subprime mortgage crisis. They had to file for Chapter 11 bankruptcy on September 15, 2008, which remains the largest bankruptcy filing in US history. As a result, the Dow Jones closed over 4.4% or 500 points lower that day. A larger 6.98% dip followed it on September 29, 2008.
It took some time for stocks to recover from the market crash of 2008, and in March 2013, the Dow Jones bounced back to its October 2007 highs. Stock prices rose faster than earnings in 2013, creating an asset bubble, and the Dow continued to set higher records until February 2018. Like many previous stock market crashes, the 2008 crash did not lead to a recession.
The great lockdown of April 2020
The most recent impact that we have seen the market recover from was during the COVID-19 pandemic. In the week of February 2020, the S&P 500 and Dow Jones plummeted 12% and 11%, respectively. The Dow declined by 9.99% on March 12, marking its largest one-day drop since Black Monday of 1987, which was followed by an even steeper decline of 12.9% on March 16.
From February 12 to March 16, the NYSE trading was suspended multiple times since the drop in stock prices was rather sudden and dramatic. However, the stock market managed to rebound to its pre-pandemic peak by May 2020. By August 18, the S&P was reaching record highs and on November 24, 2020, the DJIA crossed the milestone of 30,000 for the first time in history.
Why should you buy the dip?
From history, we can see that if you are a long-term investor, the past few historical dips have always shown U-shaped or V-shaped recoveries. Markets have always recovered, and people who buy the dip and globally diversify, see great returns.
If you're still not convinced to buy the dip, then maybe you should take some insight from Warren Buffett. In the first quarter, Berkshire Hathaway Inc invested $41.5 million in net stock purchases. This is the most cash Buffet's company has ploughed in a quarter since 2008. The market's unpromising start to 2022 is likely to have played a role in Buffet's splurge. Buffet, demonstrating the patience of a smart investor, seized the opportunity to buy into the dip when the S&P 500 plunged almost 13% from its all-time high in Q1.
Long-term investors have the most to gain from buying into the dip right now. Past data has shown us that the markets are resilient, and it is just a matter of months before stock prices are back up. This time is expected to be no different. It's a big ship that is expected to turn, and it's just a matter of time before markets start to rise once more.
References:
● https://www.fool.com/investing/stock-market/basics/crashes/
● https://en.wikipedia.org/wiki/Bankruptcy_of_Lehman_Brothers
● https://en.wikipedia.org/wiki/2020_stock_market_crash
● https://en.wikipedia.org/wiki/Economic_effects_of_the_September_11_attacks