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The share market has been getting plenty of media coverage of late, and that’s no surprise given that bad news sells. The casual observer could be forgiven for thinking that the financial world is in ruin and that investors have been left penniless following the worst correction in a generation.

But let’s for a moment try to put things in perspective. While it’s true that the market has well and truly entered bear market territory, having lost around 23% over the past 10 months, the doomsayers fail to take the broader picture into account.

Chart 1: S&P ASX 200 Index performance from August 2007 to present

click here to enlarge

The first thing to understand is that what we have seen over the past year is in no way anomalous; indeed it is simply the nature of the beast. Markets and economies move in cycles and it’s entirely normal to see the market pull back from time to time. What we tend to forget is that there is usually a strong period of growth that precedes the downturn. The funny thing is that people tend to treat the correction as an isolated event, and ignore the (often irrational) exuberance that precedes it.

So let’s step back and take a wider view. What if we look at the market over the past 5 years? Or even 20 years?

Chart 2: S&P ASX 200 Index performance from 2003 to present

click here to enlarge

Chart 3: S&P ASX 200 Index performance from 1982 to present

click here to enlarge

All of a sudden the downturn is put into context. Despite the correction, the market has still gained around 60% since 2003. Hardly reason enough to proclaim the end of the world.

To really understand the nature of the share market, let’s step back even further and see how it has behaved over the past 50 years. Over that period we can see that there is a mix of good and bad years, as shown below.

Chart 4: Annual percentage change of the All Ordinaries index from 1958 to present

click here to enlarge

There are two things I would point out about this history. Firstly, the market saw an improvement much more often than it saw a decline – in fact the ratio of good years to bad is approximately 2:1. And secondly, the gains made in the good years were of a greater magnitude than the losses in the bad years. Specifically, the average advance was approximately 21%, whereas the average decline was approximately 13%. If we consider the mean annual growth rate over the entire period, we see that the market saw an average capital appreciation of 9.4%. Factor in dividends and the average annual return climbs to around 14%. Not bad when you consider that over that time we experienced the oil shock of the 70’s, the 87 market crash, the Asian financial crisis, the ‘tech wreck’ and the current credit crisis.

But this history assumes you bought at the start of each year and then sold at the end. What if you had held your shares for 5 or 10 years?

Chart 5: 5 year rolling performance of the All Ordinaries since 1962

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Chart 6: 10 year rolling performance of the All Ordinaries since 1967

click here to enlarge

As you can see, it certainly pays to have a longer term perspective. The 5 year investment horizon had an average return of over 50%, while the 10 year time frame produced an average return of over 120% (and remember that these figures do NOT include dividends!)

I don’t mean to sugar coat or trivialize the recent correction; it’s never a pleasant experience to see your capital drop away to such an extent. My point is that we can’t view the last 12 months as ‘proof’ that the market is a dangerous place to invest. At the same time we can’t claim that the pull back is unprecedented or in any way unusual. We just have to accept that while the market can be a volatile place in the short term, over the longer term (and I’m really only talking 5 years plus) the market has an excellent record of producing significant returns. Moreover, when we take a longer term view the occasional correction, even the bigger ones, really pales into insignificance.

Make the markets work for you

Andrew Page
Trading Tutors Team

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