Our article last year about "doom-and-gloom" predictions gained a lot of attention. We revisit the topic once again.

We recently received the following question from one of our shareholders. If you have questions you'd like to ask our team, please email us at [email protected].

On Feb. 3, 2016, Nate Weisshaar said that he would revisit the doom-and-gloom predictions of James Dale Davidson, who likened what was coming to the Japanese 20-year economic downturn. While there was no crash in 2016 (quite the contrary), Mr. Weisshaar did have an interesting analysis that I would like for him to revisit in light of the upcoming Trump economic agenda. He said that while he would not rule anything out, he doubted we’d see a major downturn because “there are several things that make the U.S. economy and stock market different from Japan’s – a cleaned-up banking system and a broadly positive view toward immigration just being two of them.”

I thought Mr. Weisshaar was going to do a Dale Davidson update in January. - Marilyn

Marilyn is correct: Last January, I promised to circle around on Dale Davidson’s terrifying predictions for the stock market in 2016 once the calendar turned.

Thanks to the benefit of hindsight, this is a pretty easy one, so I won’t even bother with the PricewaterhouseCoopers-audited envelope.

As I’m sure we all know, 2016 was a pretty good year in the market – nothing near the 1990 Japan-style crash Davidson was forecasting. After starting the year with an exciting drop of roughly 10%, the S&P 500 staged a rousing comeback and finished the year up in positive territory.

Now, I don’t want to sound too smug, because nothing says things had to turn out that way, and in late January 2016, few people would have been willing to take such a bet. (If you were one of the brave ones who bought the index at the bottom, you are now celebrating an annualized return of 20%, so congratulations.)

Instead, I’ll simply quote myself:

I won’t say that I think Davidson is wrong in his call. I just don’t know that he’s right – in scale or timing. Will we have a 50% drop in the stock market at some point? Yes. Will we have an 80% drop in the stock market at some point? Yes.

But I have zero confidence in stating when these events will occur.

In truth, little of what Davidson and many other market doomsayers based their predictions on has changed in the past year. Markets are hitting all-time highs, price-to-earnings multiples are well above historical averages, debt levels continue to rise around the globe, and The Bachelor is still around after 15 years.

Without a doubt, there are still plenty of reasons we could see a stock market sell-off. But there always will be. Actually, if we found ourselves in a place where there were no reasons for stocks to go down, I would be incredibly worried.

Hindsight is always 20/20

So while Davidson broke one of the key rules about making predictions — don’t include a time frame — the underlying lesson here isn’t about pointing fingers and celebrating someone else’s mistake. (But again, by all means, do celebrate your gains from last year).

Instead, investors should look at this and consider what could have gone differently. What if the market hadn’t bottomed out in February? What if it had fallen 50% last year? What would you be doing differently? Would you be happy with where your money was invested?

Very few, I would venture, would be happy about a stock portfolio down 50% in a year, but for those in their early 40s, that kind of drop is probably surmountable. For those in their 70s, it may not be.

All of our shareholders should consider where The Motley Fool’s mutual funds fit in their financial picture. While we do our very best to invest your money in great companies with strong long-term potential, the fact that we invest only in stocks means we — and you — will be notably affected by broad stock market moves.

Even great companies can stumble (Chipotle, anyone?), which is why our mutual funds are invested across 30 or more companies. We believe diversification is one way to improve potential long-term returns. (Note: Diversification does not ensure against a profit nor protect against a loss.)

Similarly, investors should consider how well their overall portfolios are diversified. If you’re nearing retirement and are counting on the principal in your portfolio, do you have enough diversification across asset classes — stocks, bonds, real estate, gold? If the fear of a 50% drop in the market makes you lose sleep at night, you might want to reconsider some things.

So we can mock fears of yesterday with today’s knowledge, but I think it would be reckless to ignore the fact that just because it didn’t happen last year doesn’t mean it won’t happen at some point.

The Bottom Line

Market drops are just one of the realities of investing. I haven’t yet seen proof that they can consistently be avoided, unless you consistently stay out of the market.

However, to date, market drops have not been the end of the world, and investors with the stomach to invest through the fear have generally been well rewarded.

On a related note, in response to our anonymous question submission, I have to say that a meaningful effort to shut off immigration — as well as a general sentiment against a more open world — would be likely to stifle global growth. In that scenario, Davidson’s concerns that we’ve mentioned take on additional weight.

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