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After the Swan Dive

Bill Kosar

I’VE BEEN RETIRED for six years and—like many retirees—I rely on my portfolio’s appreciation, interest and dividends for most of my retirement income. The high inflation of 2022, coupled with poor stock and bond market returns, have me pondering what history would predict for 2023’s performance.

I decided to look at how frequently both the stock and bond markets have performed poorly in the same year, and what subsequent returns have typically been. Simultaneous declines in both the U.S. stock and bond markets might be considered a “black swan” event—something far outside what’s normally expected. The term was made popular by the bestselling book by Nassim Nicholas Taleb.

And, yes, 2022 qualifies as a black swan: Simultaneous annual stock and bond declines have occurred just five times over the past 95 years, as you’ll see in the chart below, and 2022 was the first year when both stocks and bonds posted double-digit drops. The chart shows the total annual returns for the S&P 500 and 10-year Treasury notes for 1928-2022, which I got from the site maintained by New York University finance professor Aswath Damodaran.

What does Damodaran’s historical data tell us? My conclusion: Markets tend to have healthy recoveries in the three years after bad years. Indeed, for a 50% stock-50% bond portfolio, all four of the prior black swan years were followed by at least three up years, with the cumulative three-year gain ranging from 27.5% to 57.8%. While black swan years have been relatively rare, the data suggest that maybe investors in those years were overreacting to fears of future economic problems that didn’t come to pass.

The lessons: It’s important to maintain a large enough cash reserve to cover at least three years of your foreseeable retirement spending, so you’re never forced to sell long-term investments at low prices to cover your short-term spending needs—and it’s equally important not to overreact to a single bad year.

Bill Kosar retired after working for 40 years in various roles as an engineering and business manager in the semiconductor industry, where he spent much of his time doing exploratory and diagnostic analysis of technical and financial data. He has 45 years of experience with various types of investments, including stocks, bonds, options, limited partnerships and mutual funds, and is familiar with both the fundamentals and the pros and cons of these types of investments. Bill enjoys looking at economics from a macro perspective. He’s also an avid bird photographer and gardener, and mediocre golfer. 

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Roboticus Aquarius
Roboticus Aquarius
26 days ago

Periods like this are difficult for everyone, but for investors I’m convinced that they are also an opportunity.

In 2022 we doubled our retirement contributions (in $, not %), and we aim to increase contributions by a similar amount this year (3x vs 2 years ago), maxing out all our retirement vehicles.

We’re lucky to be able to do so, the benefit of 1) kids dropping off the expense list and 2) cash flow improvements from several sources.

It seems likely that this decision will pay off over the next 5 years & beyond.

Bill Kosar
Bill Kosar
26 days ago

This is the year by year data after the “black swan” years:

S&P500   US long-term    50/50 bond/S&P500
return T bond return split return
——————————————————————————————–

1932      -8.6%     8.8%      0.1%
1933      50.0%    1.9%      25.9%
1934     -1.2%     8.0%      3.4%
Cumulative 3 year
return after black
swan in 1931        35.4%    19.6%    27.5%
———————————————————————————————-

1942      19.2%    2.3%      10.7%
1943      25.1%    2.5%      13.8%
1944      19.0%    2.6%      10.8%
Cumulative 3 year
return after black
swan in 1941            77.4%    7.5%      42.5%
———————————————————————————————–

1970     3.6%      16.8%    10.2%
1971      14.2%    9.8%      12.0%
1972      18.8%    2.8%      10.8%
Cumulative 3 year
return after black
swan in 1969            40.5%    31.8%    36.1%
———————————————————————————————–

2019      31.2%    9.6%      20.4%
2020      18.0%    11.3%   14.7%
2021      28.5%    -4.4%     12.0%
Cumulative 3 year
return after black
swan in 2018            98.9%    16.7%    57.8%
———————————————————————————————–

Last edited 26 days ago by Bill Kosar
Marc Dragun
Marc Dragun
27 days ago

Bill, very helpful article.   Does the “at least 3 years of cash reserve” include the drawdown part of the Market, as well as the time needed to recover to the old high?  For example, if 2022 was a drawdown year (“black swan”) requiring tapping into the 3-year cash reserve, will the remaining two years of the cash reserve be sufficient to, on average, have us return to the old high, set in Jan of 2021, where we can start selling equities to fund retirement?

Bill Kosar
Bill Kosar
27 days ago
Reply to  Marc Dragun

Marc, interesting question.

  Three years of cash reserves means sufficient cash to cover your normal spending for this period of time. I want to have sufficient income to live comfortably every year of my retirement and I don’t want to crimp my lifestyle for financial reasons while I wait for a market recovery.    
 
The large cash reserve is needed so you can avoid selling any long-term investments while the market is depressed or recovering from a major drop. The historical data shows that it is very likely that the S&P500 will completely recover the losses it sustained in the “black swan” year of 2022 during the next three years and you would therefore be far more willing to sell some of your long-term investments after that recovery has occurred. It should be noted that the historical data on the 3-year returns of the long-term bond market after a “black swan” year is much less encouraging than the same data for the S&P500 but the S&P500 data is so good it pulls the overall average up substantially.

Andrew Forsythe
Andrew Forsythe
29 days ago

Bill, thanks for the timely article. Here’s hoping for a more rewarding 2023!

William Perry
William Perry
29 days ago

I hope writing articles for Humble Dollar is a new year’s resolution for you. A good and informative article.

Best, Bill

Patricia shmidheiser
Patricia shmidheiser
29 days ago

Nice article. However, I think the term gray swan might be more appropriate according to page 272 of Taleb’s book. If the next three years show a huge cumulative loss, that might be a black swan.

R Quinn
R Quinn
29 days ago

How do dividends and interest figure in? Does the average annual return include both of those? For the most part div and int keep chugging along even as prices decline.

For someone who uses cash to avoid selling in down markets it seems reinvesting the div and int during that period is an opportunity for future growth.

Rick Connor
Rick Connor
30 days ago

Bill, thanks for the interesting article, the link to the data, and a glimmer of hope in the new year.

Edmund Marsh
Edmund Marsh
30 days ago

Thanks for your article, Bill. I appreciate an encouragement to stay calm in the face of adversity.

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