The rapid spread of the coronavirus (COVID-19) outside of China sent the U.S. stock market down last week over rising concerns that the coronavirus will impact the global economy. Last week the S&P 500 had the worst one week drop since 2008. Here’s how the week went…
- Monday: -3.35%
- Tuesday: -3.03%
- Wednesday: -0.38%
- Thursday: -4.42%
- Friday: -0.82%
At the close on Friday, February 28th we had a -12.76% drawdown from the all time high set by the S&P 500 on Wednesday, February 19th. This -12.76% drop in seven trading days is one of the fastest corrections we’ve seen.
What’s not unusual though, is that a -13% drawdown happens almost every year. The chart below shows that the S&P 500 has had an average intra-year decline of -13.8% over the past 40 years.
In percentage terms, the drawdown we’ve had this year isn’t even as large as the 20% correction we saw in the 4th quarter of 2018, yet it feels worse because the correction happened over seven straight down days.
The speed of the losses and the constant stream of news about the virus in the media is enough to scare anyone. Last week was a humble reminder that the definition of volatility means we will have to experience pullbacks, corrections, and bear markets along our journey to build wealth. History has shown that markets never go up and to the right in a linear fashion.
But the headlines we saw last week, just days from all-time highs in the market, were enough reason to confuse investors. What should you be doing? With this rapid turnaround in market direction and fears that the coronavirus will turn from an epidemic to a pandemic, should you be taking action? If so, what sort of actions should you take?
Paralyzed, confused, and fearful; investors are asking themselves what they should be doing next. Is it time to sell and go to cash to ride out the storm, or is this actually an opportunity to buy? Confused by the correction, many investors are even turning to Google for help.
All I had to do was type “should I” in a Google search and the top two predicted searches that appeared next were:
- Should I buy stocks now?
- Should I sell my stocks?
Nobody really knows how long the coronavirus threat will last. As you wait it out, it’s scary seeing your account balance take a daily hit. The drawdowns are shocking following a year where the market was up 30%+. You were already getting used to that new high watermark you hit just a week ago.
Research tells us that it’s human nature to have a greater emotional reaction to a drawdown than you do a gain of the same size. Loss aversion is an important concept associated with an economics theory developed by Daniel Kahneman and Amos Tversky called prospect theory. Loss aversion suggests that people express a different degree of emotion towards gains (happiness or pleasure) than towards losses (stress or pain). It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining.
The pain and anxiety we feel during market downturns is the price we pay for the superior returns that can be made in the stock market.
Nevertheless, investors are unsure of their next move. It’s human nature to have a fight-or-flight response when we experience a market decline as quick and steep as last week’s loss.
Just take a look at the recent spike in Google’s search trends:
Should I buy stocks now?…
Should I sell my stocks?…
Is The Panic-Selling Justified?
If you look at the facts we’ve seen about the coronavirus (COVID-19) the stock market selloff seems like a big overreaction. While I don’t claim to know exactly how bad the coronavirus epidemic will get, it seems that the decline in stocks last week was just as a function of panic-selling over fears of what could happen rather than over what is happening to the trajectory of the economy.
That doesn’t mean selling is over. While a number of indicators would suggest forward returns from current levels should be pretty good, further declines in the near-term cannot be ruled out.
In this environment, investors are best-served by accepting and ignoring volatility, rather than taking it as a signal of an inevitably worse outcome.
Here are some things to consider:
+ The economy remains fundamentally strong. Over the past two weeks my view view for the US economy hasn’t changed. Americans are working, their incomes are rising, and their balance sheets are strong. As a result, the US consumer is in good shape financially and will continue to be a key driver to growth.The job market remains very strong with a historically low unemployment rate of 3.6%.
+ The Fed cut interest rates by 0.50% this morning. Federal Reserve Chairman Jerome Powell said the coronavirus outbreak had increased risks to the U.S. economic outlook, prompting the central bank to deliver an emergency rate cut.
+ The rate of new cases and deaths in China is slowing.
+ The U.S. stock market now has valuations that look extremely cheap compared with bonds. As of last Friday, the dividend yield on the S&P 500 (1.81%) was higher than the yield you can get from a 30-year Treasury bond (1.65%, a record low). With the exception of the darkest days in the financial crisis in 2008, this scenario is unprecedented. It is has certainly never been seen when the U.S. stock market is only 9 days removed from an all-time high:
My Outlook From Here
An interactive map from Johns Hopkins Center for Systems Science and Engineering and data from Worldometers allows you to see the spread of the coronavirus in real-time. I don’t claim to have any idea how far this outbreak will spread, or how many lives it will claim, before it is brought under control.
However, I know that many of the world’s leading doctors, virologists and epidemiologists are working on treatments and vaccines. I believe that their combined efforts and human ingenuity will ultimately succeed. Clearly, this is just my opinion based on the knowledge and technology we have available.
My belief that this is just a temporary problem and setback for the market is also based on the history of similar outbreaks in the past 20 years.
Consider past epidemics like:
- 2003-2004: SARS, which also originated in China
- 2005-2006: the bird flu epidemic
- 2009: a new strain of swine flu
- 2014: the Ebola outbreak
- 2016-2017: the Zika virus outbreak
The first day of these 5 epidemics was January 31, 2003 which was the beginning of the SARS epidemic. On that day the S&P 500 closed at 855.70.
17 years and 6 epidemics later (including the current one), on Friday, February 28, 2020 the S&P 500 closed at 2,954.22 points which is nearly 3.5 times higher! The market is resilient as it has recovered from any and all declines from past epidemics.
Like all other viruses in the past I expect that the coronavirus will eventually dissipate.
So What Should I Do With My Investments?
Bottom line: This is not a time to panic! Don’t let fear drive your investment decisions. Stay focused on your financial plan. Keep calm and stay invested.
This decline we are going through is within normal ranges of stock market volatility. If history has taught us anything about investing, it’s that declines like these are temporary and the price we have to pay for the long-term premium returns of the stock market.
The truth is nobody knows what the market will do as we endure the coronavirus epidemic. I think Carl Richards illustrates a plan of action so well in this sketch:
Things You Can Control
While you can’t control the daily moves in the market you can control how you react. Instead of selling stocks in a downturn and turning your paper losses into real losses, consider turning downturns into opportunities.
How you react to your emotions.
Your emotions are telling you to sell right now. As markets go down, it’s human nature to fear losing money. As you watch TV or read about the spread of the coronavirus you will see a lot of red. You will hear about worst case scenarios. It’s scary. Very scary! Remember that fear is often what drives people to making the biggest mistake of their lives. I lived through this in 2008 and 2009.
Tips For Overcoming Fear
- Turn off the TV. The media is in the business of gaining viewers and selling ads. Fear sells.
- Hire a financial advisor. If you don’t have an advisor you should. A good financial advisor is there to coach you through times just like this.
- Focus on the positive news. Things like new treatments, vaccines, decelerating rates of new cases and deaths, etc.
- Look at what’s happened over the past 5 epidemics in the past 20 years. In every case, the epidemic passed and the market not only recovered, but eventually went on to new highs.
- Recognize that uncertainty is always part of investing in stocks. Look at the current bull market since 2009 as an example. The S&P 500 is up 431% in spite of the many reasons to sell along the way:
- Look at long-term charts. When investing in the market, the longer your time horizon, the lower your probability of losing money. Instead of looking at short-term performance during a correction or bear market, look at past corrections in the context of a longer time horizon.
Things That Matter
What matters most when it comes to investing? The short answer is: your goals.
If you’re not retired yet, a pullback is a gift. It’s an opportunity to buy when investments are on sale. If you were buying a month ago, now is an even better time. If you have some extra cash, now is a great time to put it to work. Here are a few things you can do that matter to your financial plan:
- Invest that cash you’ve been keeping on the sidelines for a time such as this.
- Increase your 401(k) contributions.
- Consider tax loss harvesting while being mindful of wash sale rules.
- Make a contribution to your kids’ 529 plan.
- Accelerate Roth IRA conversions.
- Accelerate backdoor Roth IRA contributions.
- Refinance your mortgage.
If you are retired, then your portfolio should be prepared for a typical correction or bear market. Now is not the time to abandon your investment strategy. This correction is no different than past corrections. The worst thing you can do is sell when markets are down.
You wouldn’t be human if you didn’t fear loss. Smart investing can overcome the power of fear by focusing on relevant research, solid data, and things you can control. Investors who can tune out the news, focus on their long-term goals, and turn declines into opportunities are better positioned to succeed with their investment strategy. Stay calm, focus on the things you can control, and those things that will help you achieve your goals. The odds are quite high that in 2030 you can look back at this moment and be thankful that you resisted the urge to make emotional decisions in times of market turmoil.