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As an investor, the sudden drop in your portfolio value is likely causing distress and panic. The panic is perhaps magnified by the 24-hour news cycle touting this as an unprecedented extreme event.

Experienced investors might be quick to point out the financial crisis of 2008 or possibly Black Monday of 1987. Anecdotally we know that these extreme events happen quickly, but infrequently.

But are they actually that infrequent?

This is precisely what my colleague Dr Paul Kaplan took concerted look at in his recent article entitled “Black Turkeys, Fat Tails, and a Gaggle of Economists” in this month’s Morningstar Magazine.

While market crashes have been called black swans (a black swan being unique negative event that could not be foreseen because no similar events had occurred in the past), a careful look at historical market data actually shows that large market corrections occur on average about every six years here in Canada.

Larry Siegel, Director of Research at the CFA Institute Research Foundation, coined a more appropriate term, black turkey. He defines a black turkey as “an event that is everywhere in the data—it happens all the time—but to which one is willfully blind."

To understand the extent of these occurrences, Dr Kaplan looked at the history of several markets including Canada, the UK, and Australia among others, over the past 64 years ending February 2020.

Exhibit 1. Growth of $1 and peak values of the S&P/ASX200

cumulative growth of $1

Source: Morningstar Research Inc 

In order to define what he and Seigel call “black turkeys”, Kaplan used periods of 20 per cent decline or more as a proxy for a black turkey (otherwise known as a bear market).

On the chart above, he also plotted the highest level of cumulative wealth achieved before each of these events to help understand the extent to which investors felt the pain of said events.

Although a common measurement of pain might be to look at the maximum drawdown of an index or a fund, Kaplan opted to look at the extent of losses in tandem with the recovery period, or the amount of time it took for the index to get back up to its peak value from before a correction.

By doing this, he was able to create a “Pain Index” which measures the area underneath the peak value of the index during a black turkey event and the line representing the index. As is the purpose of all indices, it gives us a reference point for comparison.

Exhibit 2. A flock of turkeys: largest decline in the Australian index

peak index

Source: Morningstar Direct

Over the past 64 years, there were 11 bear markets. Though not evenly spread out, that averages out to an event every six years or so. The event with the highest level of pain was between 1928 and 1936 known to most as the Great Depression, a period of drastically reduced global economic demand and low commodity prices. Sound familiar?

In terms of the pain index coined by Kaplan, the Great Depression was the most painful, followed by the tech bubble in the early 2000s, and then the latter portion of the great depression/World War II.

The ”pain” index measures the combination of how bad the crash was, but also the amount of time it took to recover. Even though the decline on the index during the financial crisis was ranked second in the table, the event ranked fifth in terms of pain. 

As unsettling as this data is, the key takeaway here is that markets do crash more frequently than our recency-biased minds care to remember—but they also recover.

Exhibit 3. The most painful bear markets and recovery periods in Australia

The five most painful bear markets and recovery periods in Australia

Source: Morningstar Direct


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