The uncertainty surrounding the spread of the coronavirus known as COVID-19 is unsettling, both on a human level and an investment level. The uncertainty of the impact of COVID-19 on the global economy led to extreme levels of stock-market volatility this past week, including the largest single-day percentage declines in both the Dow Jones Industrial Average and S&P 500 indices since 1987, the largest one-day percentage gain in the Dow and S&P since 2008, and the end of the stock market’s 11-year bull run as all major market indices entered bear-market territory – defined as a decline of 20% or more from the peak.
We’ve been asked on several occasions in the past few days how this event compares to the 2008 – 2009 Great Recession. To us, it seems more reminiscent of the 9/11 attacks. In both cases, the events were unexpected, deeply impactful on an emotional level, and provoked an enormous sense of uncertainty.
Beyond its very real impacts on businesses in every sector, COVID-19 is interfering with our ability to connect with our families, community, and society in the ways to which we’ve become accustomed. Such extreme events impact us on an emotional level even more than an analytical level. Behavioral economics (the study of how our emotions influence our financial decision-making) finds that people become significantly more risk averse when faced with extreme and unexpected events, because they trigger our basic survival instinct. This is why we’re seeing the sort of “sell first / ask questions later” mentality that pervaded the stock market this past week. Even market sectors that normally benefit from declining interest rates and energy prices traded significantly lower in an environment where we would expect the exact opposite.
When panic selling grips the market, it requires a herculean effort for investors to stay the course and not abandon their long-term investment strategy. These are the “blink moments” we often reference – the moments when investors either summon their resolve and stay the course, or lose their faith in the markets and flee for the exits.
Perspective is vital in times of market extremes. With that in mind, here are five things to keep in mind in the days and weeks ahead:
1.Global stock markets, throughout history, have rewarded discipline through all sorts of geopolitical turmoil, natural disasters and economic downturns:
2. While each global health crisis has had its own unique characteristics, the stock market has consistently rebounded from the dozen or so epidemics since 1970:
3. Market declines – even severe ones – are an inherent part of stock investing. If there were no declines, then there would be no risk; everyone would invest in stocks, thus eliminating the reward for bearing the risk. While past outcomes are not a guarantee of future results, a recovery and new market highs have always followed previous declines:
4. While sudden market downturns are unsettling, sticking with your investment strategy puts you in the best position to capture a recovery. A broad market index tracking stock data since 1926 shows that US stocks have generally delivered strong returns following steep declines:
5. Reacting emotionally to short-term events can dramatically hurt long-term performance. As we observed last week, trying to time your way in and out of stocks is extremely difficult. Volatile markets are inherently unpredictable, with huge moves up or down often occurring at the beginning or end of the trading day. And history shows that 50% to 60% of the market’s best trading days in the past two decades occurred within two weeks of its 10 worst trading days. Investors who try to time the market in order to avoid increased periods of volatility will likely miss out on some of the biggest rallies, hurting their long-term returns as a result.
Financial science and long-term investing principles affirm the advice we’ve provided over the past two weeks: Stay the course in times of market extremes and stick with the long-term investment strategy that we designed for your unique situation.
As always, we welcome your questions and are available to discuss your personal situation.