There’s a lot of talk of an AI bubble in the market right now. While we don’t see a bubble in the S&P 500 based on historical context, we acknowledge there has been bubble-like behavior in different areas of the market. Bubbles forming and bursting have been the culprits of some of the worst returns for the S&P 500, such as in 1931 (Margin bubble), 2000 (Dot Com bubble), 2008 (Housing bubble). We take a look at what tends to do the best when a bubble bursts so we can turn to the benefits of diversification regardless of market dynamics.
What do bad years look like? 
We define a “bad year” as any year in which the S&P 500 fell 10% or more. There have been 12 such years since 1928, or 12% of all years. Interestingly, four of these years “cluster” — I.E. they happen in back-t0-back years. For example, 1930 & 1931 both fell 25% and 44%, respectively. We see other clusters in 1940-1941, 1973-1974, and 2001-2002.
One positive is that the length of time between clusters has gone up. For instance, from 1930-1931 to 1940 it was only 10 years between big back-to-back losing years. But then we went 30+ years (until 1973-1974), and then almost 30 years again until 2001-2002. Big losses have become less frequent (as a separate conversation, this makes sense to us given our belief that markets become more efficient over time).
What does well when stocks do poorly?
Next, we looked at each of these years and asked the question: “What tends to do well when the S&P 500 is having a bad year?” Not surprisingly, bonds are at the top of the list.
The simple takeaway: if you’re worried about an AI bubble, you should double check your bond allocation. Corporate bonds and 10-year treasury bonds both provided positive median returns during the worst years for stocks. Gold, thought of a safe-haven, has also done a good job smoothing out stock market volatility. While the median return is flat for gold, there are some standout years.
For example:
- 2008: S&P 500 fell 36%… gold rose 5.50%
- 2002: S&P 500 fell 22%… gold rose 24%
- 1974: S&P 500 fell 26%… gold rose 11%
Furthermore, the only time gold fell more than 5% while stocks fell more than 10% was in 1931… on the heels of the Great Depression.
Taken together, gold and bonds have served as strong performers following some of the worst recent market routes.
What about the bounce back?
Say the market does “bubble and burst” how quickly do stocks bounce back and what is the long-term trajectory? Here, long-term investors should be encouraged. While the year-after a bad year can be a bit of a coin flip, longer-term returns stray deeply positive. Indeed, forward returns in the five years after a “bad year” are a median +117% with no single negative outcome (the worst 5-year cumulative return is +47%).
Markets can and do suffer painful declines, especially when pockets of speculation unwind. But history makes one thing very clear: while the short-term aftermath of a big down year can be choppy, the long-term recovery is remarkably consistent. As always, our focus remains on building portfolios that expect volatility, not react to it. If you’d like to review your allocation through this lens, or stress-test your plan against different market environments, we’re here to help.
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