Rising inflation and growing recession fears delivered a one-two punch to the global capital markets in Second Quarter 2022.
The Dow Jones Industrial Average fell 10.78%, while the broader S&P 500 index declined 16.10%. Small stocks, as measured by the Russell 2000 index, dropped 17.20%. Bonds provided little cushion to the stock declines, as fears of interest-rate hikes sent the Barclays’s U.S. Aggregate bond index down 4.69%.
Wall Street analysts and pundits are making all manner of dire economic predictions in the financial media. Yet, while a recession may well be in the offing (if we’re not already in one), there are still positive economic indicators out there, with unemployment low and the housing market remaining strong. The balance sheets of U.S. consumers are strong as well, with household debt as a percentage of GDP still well below 2008 levels.
Much of the recent volatility is likely attributable to markets attempting to sort out the good from the bad and discern the near-term direction of the economy. But even if a recession does come to pass, there are really only two options for long-term investors:
1. Do nothing; or,
2. Do something
In this case, “do something” means pulling some or all of your portfolio out of stocks and into the so-called safe haven of cash. Many investors did exactly that in the early stages of the pandemic in 2020, when the global economy shut down and the S&P 500 plummeted nearly 40% in just four weeks. Millions of investors ran to the sidelines, locking in steep losses and waiting for things to “calm down” before they got back into stocks.
Unfortunately for them, they spent the next 20 months watching stocks climb higher and higher while they missed out on the party. From April 1, 2020 through December 31, 2021, the S&P 500 gained nearly 90% without experiencing a decline of even 10%.
Now that stocks have fallen well below their highs, the opportunity to get back in the stock market has finally arrived for these investors. Yet a look at the American Association of Individual Investors’ “Survey of Investor Sentiment” the week of June 22 – when the S&P 500 hit its recent low – showed that only 18.2% of individual investors viewed themselves as bullish, while 59.3% considered themselves bearish (22.5% were neutral).
Disciplined investors view a bear market as a great opportunity to invest available cash into stocks trading at deep discounts. But the people who fled the market in early 2020 are anything but disciplined. They’re panicky, emotion-driven investors, and they’re clearly not viewing the current stock sell-off as a buying opportunity.
These are the consequences of “doing something” in anticipation of, or reaction to, short-term market conditions. Investors who choose that option may feel better in the moment, but in the long run they end up paralyzed and miss out on gains that were there for the taking if they had just stayed the course.
* * * * *
One of the main reasons investors become panicky when the stock market heads south is that they’re overly concentrated in just a few stocks.
For diversified investors, it’s easy to rationalize staying invested in even the worst downturns, because history shows the stock market has always recovered from every crisis over time.
The same can’t be said, however, of individual stocks. There are no guarantees that any given stock won’t suffer declines far worse than the broad market, and no guarantees it will recover from those losses.
So when volatility seizes the market, investors in individual stocks get anxious, because they don’t know where the floor is. The more the volatility ratchets up, the more panicky they get, until they eventually throw in the towel and turn paper losses into real ones.
That’s exactly what’s happened recently to investors who piled into many of the hottest tech stocks of recent years. The declines from their highs for many of those stocks are staggering:
|
|
-52.8% |
|
Netflix |
-69.8% |
|
Spotify |
-56.0% |
|
PayPal |
-60.8% |
|
DocuSign |
-56.8% |
|
Roku |
-57.9% |
|
Snapchat |
-70.3% |
|
Shopify |
-73.6% |
The news has been equally grim for investors in cryptocurrencies. As of June 30, Bitcoin was down 70% from it’s 2021 high, and there is a full-on meltdown occurring in nearly every corner of the crypto sector with no end in sight.
It’s easy for diversified investors to get “return envy” when eyeing gaudy returns being generated by high-flying stocks and sectors. Diversification is like diligently eating your broccoli while the kid next to you is bingeing on Gummi Bears. We know our disciplined approach will pay off over time, and we know the other kid’s sugar high won’t last forever, but sometimes it just seems more, well…fun.
As the saying goes, it’s all fun and games until someone gets hurt. Countless investors who couldn’t resist the temptation to pile into the tech and crypto sectors have been badly hurt in recent months. Many will never recover their losses.
A little food for thought while you’re eating your veggies and patiently playing the long game.