Does a market crash affect mutual funds?

Stock market crash: when share prices suddenly plummet

"There is a ghost haunted the stock markets - the ghost of the stock market crash." Once again. But what exactly does "crash" mean, and what can you do as an investor in such a stock market crash?

In turbulent stock market times, "crash" is a catchphrase that likes to exaggerate and that is used too often. For some, there only seem to be extremes: either rally or crash, bull or bear. You should start a few sizes smaller and save the full-blown stock market crash for the worst cases.

Volatility is the norm

Share prices fluctuate. They fluctuate more intensely than, for example, the prices of euro government bonds. That's kind of her job. The higher risk is the reason why an investment in the asset class of stocks can expect a higher return than one in bonds. This volatility, i.e. the range of fluctuation in indices and individual values, is completely normal. "Historical volatility" means: The fluctuation is calculated from time series from the past. “Implied volatility” means the fluctuation that the market is currently expecting.

No stock market without volatility. This is why Harry S. Truman's saying applies: "If you can't stand the heat, stay out of the kitchen." if you can't stand the inevitable price fluctuations. This is not a test for machos, in which the most risk-taker wins, but an honest assessment of one's own risk tolerance.

ETFs: the right investment strategy counts!

As with individual stocks, ETFs have different countries, industries or key topics that can be mapped with index funds. But which ETF do I even need and what does the perfect asset allocation look like? Let the best asset managers in Germany put together your ETF portfolio - so that your money can work for you in a relaxed way.

Consolidation and correction versus stock market crash

Consolidation is also quite normal, although a stock index can lose up to five percent of its value. Consolidation means that prices have risen sharply, but then decline slightly or move sideways. The stock market takes a breather from the rise, but continues the upward trend later. What remains is the generally positive mood on the stock markets. A consolidation can take several days, or several weeks in the case of a sideways movement.

If there is a correction, stock prices move down because they previously exaggerated it. This downward movement is more severe than in the case of consolidation and can last for several months. The range of price declines is wide: share prices can fall by up to 20 percent. Individual stocks can also fall more sharply. Because of the wide range of price drops, the frequency of corrections also differs. The US news channel CNBC published the following statistics in early 2020:

  • A drop of five percent or more occurs about three times a year (for an average of 47 days).
  • The stock market sinks ten percent or more about once a year (for an average of 115 days).
  • A decrease of 15 percent or more occurs approximately every two years (for an average of 216 days).
  • The market drops 20 percent or more about every 3.5 years (for an average of 338 days).

From 1945–2020 (without the corona crash) there were a total of 26 corrections on the stock exchanges. On average, prices fell by 13.7 percent. On average, the stock exchanges recovered in four months.

If a correction is over, the stock market continues to rise. The overarching, long-term trend in the markets continues. Previously overpriced stocks are attractive again and offer themselves to be bought.

A full-blown stock market crash erases long-term trends

Wherever a stock market crash hits, grass no longer grows: in the event of a real crash, nothing continues afterwards. A trend then has to start all over again. A stock market crash can also completely erase long-term upward trends. According to this definition, the "corona crash" was not a stock market crash: The upward trend up to February 2020 collapsed massively, but recovered again from mid-March and continued. The Dax, Dow Jones and MSCI World ended 2020 with record highs.

A classic crash according to this definition, on the other hand, was the financial crisis from mid-2007: It was not until March 2009 that a new long-term upward trend began.

However, a crash can also be defined more narrowly: The share prices collapse by more than 20 percent in a single day. This is usually accompanied by bad financial and economic news, which leads to panic among investors. One example is "Black Monday" on October 19, 1987, when the Dow Jones Industrial dropped 22.6 percent in one day.

There has never been a stock market crash in Germany - has it?

On that "Black Monday" the Dax collapsed 9.39 percent. That was a long record. Until March 12, 2020: Since the Dax lost 12.24 percent during the "Corona crash". The Dax had never lost more in one day. According to the narrow definition, the German benchmark index has no stock market crash at all. Of course, the Dax is well aware of the extinction of long-term trends. The "New Market", which crashed when the dot-com bubble burst around the turn of the millennium and the stock market segment was finally closed in 2003, is still notorious.

The new market was founded in 1997. The stock markets were euphoric at the time because of the "New Economy". The US stock exchange Nasdaq was the model for the Neuer Markt. At the turn of the millennium, the "New Technologies" companies were valued beyond good and evil. Some new market companies had a higher market value than the big-name industrialists from the Dax. The speculative bubble did not only exist in Germany, but as a worldwide bubble (dotcom bubble), and it burst in March 2000. This countermovement in prices was so violent that Deutsche Börse dissolved the Neuer Markt, with the TecDax as its successor.

In any case, according to both definitions, a real stock market crash does not only affect one country. Due to globalization and globally intertwined economy and finance, we are all in the same boat. Which leads to the reassuring insight that the same recommendations apply to all of us in an emergency.

Can ETFs trigger a stock market crash?

What about ETFs and stock market crashes? Are index funds a threat to the stock markets? In its monthly report from October 2018, the Deutsche Bundesbank said: No, but ETFs are increasingly important for investors and the financial system. The share of the assets of the funds managed worldwide (not shares) is still 14 percent and plays a subordinate role. However, the proportion of index funds is growing faster than that of traditional active funds. However, the Bundesbank sees the specific risks of ETFs for the financial system as limited.

Something different applies to a flash crash. This is not a crash, at least not in the sense of the above definitions. A crash is like a joint operation, after which you have to go to rehab for a long time. A flash crash is like a quick twist, after which you immediately move on. On the stock market, prices drop sharply and recover within minutes. "The" flash crash occurred on May 6, 2010 at 2:32 pm New York time and lasted 36 minutes. The S&P 500 fell nearly six percent and then bounced back. After this incident, the world's stock exchanges decided to install fuses that blow out when overloaded, the so-called circuit breakers. With the S&P 500, trading is suspended for five minutes if stocks have previously lost more than ten percent of their value in five minutes.

The Bundesbank comes to the conclusion that ETFs can intensify particularly turbulent phases in the markets. In the event of a flash crash, the market price of an index fund and the index itself (such as the MSCI World) can drift apart. However, this is about topics that are relevant for high-frequency trading and not for the typical private investor. An ETF on the MSCI World always shares the fate of the MSCI World, regardless of deviations for half an hour.

The bear market: a protracted crash

A bear market is also called a bear market. On the stock exchange, the bears symbolize falling prices. (“The bear baisst.” He hits down with his paw. Bulls poke their horns upwards. They stand for rising prices.) Like a crash, a bear market requires prices to drop by at least 20 percent, calculated from their peak. However, this price decline extends over a longer period in which pessimism prevails. Such phases can last from one to several years.

Some even only speak of the bear market if the price drops by at least 20 percent within six months. A bear market can result from an economic crisis, rate hikes, political unrest or a loss of investor confidence. The bulls with the bull market stand for the opposite. A bull market means continuously rising prices. Good for optimists: a bull market lasts an average of eight years (the current one has already been running for twelve years), a bear market just under 1.5 years.

Will the next stock market crash come in 2021?

Nobody knows when the next stock market crash will come. This is down to the nature of crashes that happen when you don't expect them. Big investor and fund manager Peter Lynch says, "Nobody has ever been able to predict the stock market. It's a total waste of time." This is what the manager of the legendary Magellan Fund says, which has given its investors an average annual return of 29 percent.

Lynch also says, "Far more money has been wiped out by investors preparing for corrections or trying to anticipate market corrections than has been wiped out by the corrections themselves." Crash prophecies in particular are only something for widow Schlotterbeck with her glass ball from "Robber Hotzenplotz".

How is investor sentiment currently looking? Typically, a crash is preceded by euphoria. A stock market saying goes: "Bull markets die in euphoria". What does CNN business's Fear and Greed Index, which measures fear and greed in the markets, say?

Source: Screenshott CNN.

The mood on the stock exchanges is somewhere between fear and greed. CNN calls it "neutral". You could also say "balanced". So the sentiment currently does not speak in favor of a crash.

Does the Warren Buffett indicator show a 2021 stock market crash?

Warnings about the Warren Buffet indicator have recently surfaced. Shares are currently completely overpriced. The indicator measures the ratio between the gross domestic product (GDP) of the USA and the Wilshire 5000 share index, which contains all US companies on the stock exchange: that is, the ratio between the economy and the stock exchange. This quotient is currently around 230 percent. That's how much higher US stocks are than the US economy.

But what does that say about the risk of a crash? The great investor Warren Buffett understands the indicator named after him only as a key figure with limited predictive power. Before the dot-com bubble burst, the indicator was 118 percent; at the beginning of the subprime crisis, it was 100 percent. The Buffett metric would not have made anyone suspicious back then.

The indicator also underestimates the role of central banks and monetary policy. Shares have been rising in line with the money supply for a long time, and this in particular has increased sharply during the Corona crisis. In addition, the big US companies earn their money globally and not limited to the US. Therefore, it falls short of using only the US economy as a comparison with US stocks.

Will an overvaluation of stocks lead to a bubble and stock market crash in 2021?

One often reads that stocks are valued far too high globally and have created a bubble. Therefore a crash is to be expected. To calculate the valuation, various key figures are used, such as the price-earnings ratio (P / E), which divides the stock market price by the earnings per share.

The so-called Shiller P / E ratio, for example, uses the average of the past ten years for profit. It should first be made clear that before the "Corona crash" in early 2020, the global stock market was fairly valued. Stocks were by no means in a bubble or bubble. Even before the stock market crash in 1973, stocks were valued on average, and before the subprime crisis in 2008 they were not particularly expensive. In contrast, the Shiller P / E ratio reached record highs before the stock market crashes of 1929 and 2000.

It follows that the valuation of stocks is just one of many metrics. British investor Jeremy Grantham emphasizes that high valuations alone are not a sufficient indication of a bubble and its bursting. A P / E ratio also makes it impossible for investors to predict where the reversal points lie in the course and how they should align their actions.

What can investors do in a stock market crash?

If there is a crash, the world seems to end for investors. There is fear, panic. In moments like this: keep calm, absolutely. Every stock crash will pass, and then it will go up again. You should never sell individual stocks because the entire market is crashing, and you should also hold broad equity ETFs because they will strive for the long term.

A long-term approach is important for the necessary serenity: Buy & Hold. In the stock market, it is often best not to do anything. You can also generally use setbacks to buy more shares. But that should always be done according to a system, never out of impulse. Around minus ten, 20 and 30 percent of the high. How well the cost-average effect worked in the "Corona crash" is explained in the YouTube video.

What does the financial expert and bestselling author feel ("Honey, I bought shares! How do you lose your fear of the stock market and increase your money.") Christian Thiel in a crash? Thiel is a staunch supporter of Buy & Hold and only invests in the long term. Does he also know the uncertainty that is rampant when prices fall? "But yes," he says. "It's not a comfortable feeling." And what does he do about it? "First of all, I'll do the following: First, I don't look. I can only advise other investors. What good is it to look at these ugly red numbers? Second, I make a plan for when and how I will buy more during the crisis . Only those who buy can use a crisis to their advantage. Now stocks are cheap. " Should one even use a crash for market timing? "If you dare to see the end, you can buy it. In my experience, about one out of a million people can do that."

That is why Thiel buys according to the mentioned percentage brands. "Psychologically, buying is easiest when prices are falling. When prices rise again, most people find it harder." Thiel calls the "Corona crash" a "mega-correction" in which he bought more. "Courage grows with experience. Knowledge also helps. The steeper it goes downhill, the steeper it goes up again." So Thiel no longer knows fear on the stock market? "To be honest: What I'm really afraid of is a" lost decade "like we had in the 1970s. Or then again from 2000 to 2009. That could also be uncomfortable for me and my nerves. Though my nerves are also because of that are so good because I don't need the money that's in the market. "

And how do you calm down when you think about a "lost" decade? "What actually helps is knowing the history of the stock market. Ken Fisher with his 'Little Book of Market Myths' is a great help." One more final tip? "Avoid the stock market media. When things go bad, they spread pessimism. They increase our panic. Sober observers of the stock market have no chance there."

How ETF investment strategist Gerd Kommer acts in a stock market crash

Dr. Gerd Kommer is a luminary in financial matters: bestselling author, investment banker, asset manager (Gerd Kommer Capital) and financial advisor. It follows a long-term, passive buy & hold approach from a science-based point of view. Does he also know uncertainty when the stock market crashes? "Yes, after a strong downturn in my portfolio of, say, 20 percent, I also begin to feel uncomfortable, which gradually becomes more nagging the further it goes down. At less than 20 percent, actually not. That's why I know the stock market too good."

And how does Kommer calm his psyche? "I then try to calm myself down with thoughts and facts like the following: 'A 20 percent slump in the global stock market has happened around 15 times in the last 120 years, that's completely normal' or 'All other asset classes have it that too - with real estate, with gold, with bonds, with cryptocurrencies, it would have happened to you anyway 'or' Sooner or later you will see profits in the depot 'or' You don't need the money now, why are you upset? ' "

After all, a stock crash even has advantages for some investors: "Then I force myself to think of all the young people who have not invested much because of their age and who can now look forward to affordable entry prices. If you are young, you should Pray every day for a major crash in stocks and real estate because you will probably benefit financially from it, even if you have already invested 10,000 euros, for example. "

In any case, a stock market crash does not leave Gerd Kommer indifferent either: "" No, it is not a mere shrug for me either, at least not when things are really going down Such moments also ask how my clients are doing now, who are as invested as I am, even if not all of them with such a high equity quota. "

The past teaches us that recovery follows a stock market crash

A quote from entrepreneur and fund manager John Templeton can be used as a guide for behavior in a stock market crash: "The four most expensive words in the English language are 'this time it's different.' "In a phase of panic on the stock markets, it is easy to think that this time everything is different than before, that the old rules of conduct no longer apply. A fallacy. This already indicates that the "corona crash" did not turn out to be a stock market crash in retrospect. What can be learned from past crashes?

Let's look at six real crashes since 1900. Gerd Kommer has calculated on his blog what the key figures look like when the global stock market falls, with a maximum loss of 45 percent or more.

  • First World War and Spanish Flu: This crash lasted from late 1916 to mid-1920 (low point). In just under four years, the US stock exchanges fell 45 percent.
  • Great Depression from 1929: This stock market crash began in mid-1929 and reached its low point in mid-1932. In just under three years, the US stock exchanges fell 79 percent. That was the biggest loss on the stock markets in the past 120 years.
  • Second World War: This crash lasted more than five years from early 1937 to early 1942. This was the longest period of any crash that it took stock prices to bottom. The US stock exchanges fell 47 percent.
  • Oil crisis: This stock market crash lasted from the beginning of 1973 to the end of 1974, almost two years. Up to this low, the shares of the world stock exchanges lost 47 percent.
  • Dotcom bubble: This crash lasted from the beginning of 2000 to mid-2002, around two and a half years. By the time the world's stocks hit rock bottom, they lost 49 percent.
  • Subprime crisis: The big financial crash lasted from the end of 2007 to the beginning of 2009, a good year. The world stock exchanges fell by 55 percent.
  • On average, a crash lasted almost three years. The stock markets lost an average of 54 percent.

That reads scary. But what about after the crashes?

  • Two years after bottoming out, the stock exchanges achieved a cumulative return of 74 percent when averaged over the six crashes. The lowest gain after 24 months was 38 percent (oil crisis), the highest 149 percent (Great Depression).
  • Five years after the low, the stock exchanges achieved a cumulative return averaging 138 percent. The lowest gain after 60 months was 42 percent (oil crisis) the highest 309 percent (Great Depression).

So the sun always rises. And what's more: it usually shines even brighter afterwards.

JP Morgan advises: "Always buy at the all-time high!"

A popular stock market slogan is: "Buy the dip!" So buy in the event of a break-in. You can handle that in a crash if you think long-term and know that the markets will rise in the long run. But you can also do it differently and buy at all-time highs. For example, the major bank JP Morgan recommends it in a study.

Because the rule is: An all-time high is not followed by a low, but by a new all-time high. A good point for investments. In the long term, the stock market is a place for people with well-founded optimism: "Always invest at the all-time high," advises JP Morgan. As the bank calculates, such optimists have trumped the skeptics who have invested at all other times. But why should that be so? It contradicts the often heard warnings that the stock markets have already risen too high.

The MSCI World since 1970 / Chart:

Highs are a normal occurrence on the stock market

If you look at the stock market curves over the long term, you can see that the stock markets are mostly at a high or close to a record. If you wait for crashes, you will miss out on all of the rallies. A crash, on the other hand, is over faster than you think. The stock market punishes the constant hesitation. JP Morgan calculates:

  • If you had invested in the S&P 500 on any day since 1988 (including dividends), you would have made money 83 percent of the time next year, an average of 11.7 percent.
  • If you had only invested on days when the S&P 500 closed at an all-time high, you would have made money 88 percent of the time next year, an average of plus 14.6 percent.
  • In relation to three years, the ratio would look like this: return of 39.1 percent for investments on any day and return of 50.4 percent for investments at all-time highs.
  • In relation to five years you would have achieved 71.4 percent with investments on any day, but with investments at all-time highs 78.9 percent.

The S&P 500 since 1928 / Chart:

In the long term, the stock markets will rise. Individual values ​​always fall out of the statistics, but investors can benefit from the rise of the entire market with a broadly diversified equity portfolio or with market-wide ETFs. However, the right investment strategy also counts here.

There is the real job of the crash prophet, who earns money by scaremongering. Many media outlets like to pick up on such financial pornography because it sells well. However, rational investors should take JP Morgan's advice from the study: "There are reasons (and always will be) to worry about the outlook for the stock market. However, we continue to emphasize the importance of to look at the bigger picture in the longer term. "

Even in mid-February, when the media was full of crash worries, JP Morgan's strategists saw no imminent danger. They advised investors to stay invested: "When growth is above trend, monetary policy is ultra-loose and fiscal policy is in full swing, the markets tend to show the financial variant of Newton's law: they keep moving, until another force acts on them. "

Conclusion: The stock market is up and down - but up in the long term.

Especially in turbulent times with frequent crash prognoses, it helps to remember basic knowledge and not to be driven crazy. Anyone who has a long-term investment horizon of ten to 20 years and uses intermittent price drops to buy more should look forward to decent returns with a high degree of probability.

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