Loss and recovery
Another observation from the table is that the years of negative return have been reasonably spaced out, with gaps between them of 4, 8 and 6 years. This pattern conforms broadly to the theoretical risk of a negative return, which for growth funds is approximately 1 in 6. Note that this does not mean we expect negative years to come along at intervals of precisely six years. Rather, it means that the risk of a negative return in any single year is 1 in 6.
Looking again at the table, we can see that negative returns generally follow extended periods of quite strong performance. It seems that markets ‘get ahead of themselves’ and need a correction to pull them back towards their long-term trends. Most times the correction is relatively benign but, as we have seen, 2008 was a notable exception.
In ‘normal’ times, the years following a negative return have generally produced strongly positive returns. Again this is shown in the table. So there is some hope for those unhappy members in growth options that their fortunes will turn around reasonably quickly.
To get back to where they were at end-December 2007 (ignoring new contributions) requires a positive cumulative return of 28.5%. If we look at the three previous negative return years in our data series, on each occasion a return of about that much was achieved within two years. Whether that will happen again this time, given the severe damage being felt in financial markets and reflected in real economies, remains to be seen.
For investors looking for a turnaround, the early weeks of 2009 have provided no encouragement at all. The gloomy outlook for global economies raises the possibility that we may be facing another calendar year of negative returns. We consider that unlikely, given that markets tend to anticipate events rather than be led by them, and may well rebound later this year. However, the 2008/09 financial year will almost certainly be negative, as was 2007/08.
In theory there is no reason why negative returns could not occur in consecutive years, but in practice they tend not to. That is because these are not random events, but rather they are driven by economic and market cycles. If back-to-back negative returns were to happen it would again be highly unusual. Statistically, based on the experience since 1980, there is only a 1 in 25 chance of consecutive years of negative performance.