Is there a higher risk of a large fall when the equity market reaches an all-time high?

“Given the sharp run-up in recent weeks, I feel the risk of a large market fall has increased. Should I redeem my equity investments to avoid loss?”

If you had similar thoughts, welcome to the rest of us!

While it feels exciting to see equity markets go up, there is always a lingering sense of anxiety that they might come crashing down anytime.

I have used the word ‘crash’ here deliberately because most of us are not bothered by smaller declines where equity markets fall 10-20%.

In fact, going by the last 30+ years of Nifty 50, 10-20% falls happen almost each and every year¹ and cannot be avoided.

Our concern is usually more on the larger market declines (read as falls greater than 20%). 

With the equity markets making new all-time highs in the last two months, every small decline feels like the start of a large fall.

But is this really the case?

Do all-time highs actually increase the odds of a large market decline?

Let us find out!

First, let’s check the historical odds of a 20% fall happening in the next 1-2 years following normal (non-all-time-high) days…

Assuming your portfolio value was Rs 100, here is the percentage of times the equity market fell over 20% (read as portfolio value dropped below Rs 80) in the near future.

• 26% of the times, your portfolio value fell below Rs 80 (>20% decline) in the next 1 year following a normal day
• 37% of the times, your portfolio value fell below Rs 80 (>20% decline) in the next 2 years following a normal day

The odds of large declines after normal, non all-time high days were quite low.

No surprise here!

How bad are these odds after all-time highs?

Here comes the surprise – There has hardly been any difference between the odds of a large fall following all-time highs and non-all-time highs!

• 22% of the times (vs 26% for normal days), a large fall (decline over 20%) happened in the next 1 year following an all-time high
• 39% of the times (vs 37% for normal days), a large fall happened in the next 2 years following an all-time high

So, going by history, the odds of experiencing large declines in the future have remained more or less the same irrespective of all-time highs or non all-time highs!!

Summing it up

All-Time Highs are a natural part of any growing asset class and not something to be feared.

If you are worried about large market falls, here is what history has to tell you:

All-time Highs DO NOT increase the risk of a large decline!

So, what’s the best thing to do right now?

Keep Calm. Stick to Asset Allocation. Stay Invested.

Notes:

1. Equity Markets witness 10-20% temporary declines almost every year. Only 3 out of the last 32 years experienced declines less than 10%