September 18, 1998

What Goes Up Usually Comes Down

by Nick Khouri, Vice President

Investors around the world are learning the meaning of the old adage "what goes up usually comes down." Because the U.S. stock market has been remarkably strong since the late-1980s, some investors have come to believe that the market can only go one way, up. Historically, this has not been the case.

First, the recent bad news: Equity markets around the world have taken a beating over the last six weeks. The Dow Jones Industrial, a narrow measure of the top 30 largest U.S. companies, has fallen 19.7 percent, from a high of 9,338 on July 17 to 7,500 at the time of this writing. The Dow is now 5 percent below the 1997 year-end level.

Many current investors, and the brokers they rely on, have never lived through a bear market. Since the end of 1987, the U.S. has seen a spectacular run in the stock market. The Dow jumped from an average of approximately 2,000 during 1988 to 7,400 last year, a rise of 270 percent. This increase in the stock market was fueled by low inflation, meaning the "real" return on equities was close to a historic high.

As we have learned since July, the wise investor remembers that, except for the abnormal rise over the last 10 years, the stock market falls in nearly as many years as it rises. A look back over the past 43 years of the stock market reinforces this view.¹

The exhibit shows the annual average of the Dow Jones Industrials from 1955 to the present. During an 18-year period, from 1960 to 1978, the Dow fell in 9 years and rose in 10. Also during this period, the Dow never increased in more than three consecutive years. From 1955 to 1988, the Dow rose in 20 years and fell in 14. It is only in the very unusual 1990s that we have grown accustomed to the Dow never falling.

In 1972, the Dow averaged 950. It then fell 20 percent to 753 during the next two years. Remarkably, by 1982, ten years later, the Dow stood at 884, 7 percent below the level of 1972.

No one knows where the current fall in the stock market will bottom out. What is clear, however, is that investors who use the unusually strong performance of the last ten years as the basis for predicting the next ten years, do so at their peril.