By Matthew Theal, CFP®
Over the past two weeks, we have witnessed our first real global market panic since 2011 during the Eurozone Debt Crisis. During that time, the S&P 500 declined by 19.39%.
Over the last month, we have seen a decline of 17.73%
The current reason global markets are dropping is that COVID-19 (aka coronavirus) is spreading fast and causing high death rates for specific demographics. One week ago, we had 100 cases in the U.S. As of writing, we have 791 (Source: John Hopkins COVID-19 Tracker). By the weekend, there will be thousands.
Because of fears of the virus, we are seeing spillover effects and an economic crisis starting to take place. In the last two weeks, we have seen massive event cancellations (SXSW, Coachella potentially), flight cancellations, schools closing, sporting events canceled, or played in empty stadiums, and the cruising industry halted by the CDC (basically). Yesterday, Italy took it a step further, quarantining their whole country, becoming the first major democratic country to copy China’s strategy in Wuhan.
Making matters worse, there is a game of chicken being played in the crude oil market by Russia and Saudi Arabia. This caused a 30% intraday decline in crude oil yesterday and added to overall market weakness.
This kind of negative news will slow the economy and raises the potential for an economic recession in the latter half of 2020.
Due to the imminent risk of a recession, we have seen global stock markets around the world start to price that risk in. That is why stock markets are dropping, and interest rates are falling.
Once global markets start moving like this, advisors often get asked an excellent question by clients:
” Why don’t we sell everything now and buy once the selling is done?”
The short answer is, nobody knows when the selling is over. Fox Business and CNBC don’t run banners at the bottom of the screen saying, “THE SELLOFF IS OVER. PLEASE INVEST AGAIN.”
As my colleague Joshua Winterswyk says, “You have to be right twice.” What he means is, you have to time the top and the bottom, which is impossible.
Here’s a secret they won’t tell you on CNBC: the best days for stock market performance are clustered with the worst days for stock market performance. Moreover, looking at data from Dimensional Fund Advisors, we can see that if you were on the sidelines and missed the 15 best trading days, your return would fall from an average annual rate of return of 9.96% to 6.56%!
That’s a difference of 3.40% per year!
Another reason we don’t panic is we expect the market to fall every 4 to 5 years. This has historically been true. So we build market downturns into all of our clients’ financial plans. We build in a margin of safety and security.
See the chart below (red lines). There has never been a year where the stock market did not have a few weeks of a decline.
In short, we expect drops. That’s why we add bonds to all portfolios, and most importantly, your retirement plan hasn’t changed!
Since we can see that we are in a downturn, how does the stock market perform following one?
Using the below chart from our friends at Dimensional Fund Advisors, going back to 1926, after a 20% market decline (like we have seen) on average, the following year, stocks go higher by 14.21%!
Sometimes, the hardest thing to do is ride it out, but it’s the right thing to do. If you take a long-term perspective, it is not a bad time to invest excess cash reserves (in excess of your emergency fund), increase retirement account contributions, or rebalance your portfolio.
Don’t be the person running out of the store when there is a sale.