By: Tony Welch | Director of Investments, SignatureFD
The World Health Organization describes the symptoms of COVID-19 as flu-like in nature. Runny nose, sore throat, cough, fever and even difficulty breathing in severe cases. The stock market has probably elicited some of those same physical responses, or at least their mental equivalent, by careening into bear market territory at the fastest rate in history. This all comes on the heels of a phenomenal 2019, which saw the popular benchmark, S&P 500 Index, return 31%. It represents an incredible reversal, indeed. Last year’s entire bull market was wiped out in a matter of weeks.
Of course, the sell-off hasn’t been completely without merit. Economic data in China, where they took extreme measures to control the spread, has been atrocious. The latest data in the U.S. has begun to deteriorate, as well, and there is no doubt that millions of Americans properly practicing the new art of social distancing will result in further economic weakness ahead, which will drastically affect corporate earnings. That’s important because stock valuations (i.e. the price of a stock divided by the company’s earnings) entered the year at record highs, by some metrics. They did so because the market expected a strong earnings year, not a coronavirus-induced earnings recession.
Over the short-term, stocks can be quite volatile as they work to discount an uncertain future. We do not know how long the virus will impact our economy and those of other nations around the world. But, in crisis events like this one, it becomes even more important to think long-term and strategic. We are strong believers that an attempt at short-term market timing is one of the quickest ways to derail a well thought out financial plan. An annual study by Dalbar¹ illustrated the following last year: through the period from 1994 – 2018, the average U.S. stock fund investor made 4.6% per annum. Not too bad, but their average return was half that of the S&P 500’s return of 9.1% per annum, in the same time period. They looked at municipal bond funds, as well. U.S. muni bonds returned 3.3% per annum in that time period while the average muni fund investor returned 0%.
Why? Because it is difficult to actually follow a buy low, sell high timing discipline. Market lows are typically carved out in a period of time where a crisis feels like it will never end. It’s not easy to plug our nose and buy in that environment. Market tops typically occur when it seems like the party will go on in perpetuity. Because the market provides a constant fight with our own behavioral biases, a better alternative to market timing is one that leans into and away from risk but remains anchored to one’s long-term investment mix.
So, what should an investor with a long-term mindset begin to expect from here? While valuations are not the best market timing tool in the world (which is fine because we want to take a long-term mindset), they have been terrific at framing our risk and reward over the next decade. We already noted that the market came into the year with elevated levels of valuation. Historically, 10-year market returns have been lower than average when valuations were extended in such a manner. But, now that we’ve weathered a large drawdown, valuations are much lower. From these valuation levels, returns have been inline with those historic averages we cited above.
In real-time, crisis events like COVID-19 have a real human cost. They also can have a big market impact. But, they are impossible to forecast in advance and can be even more difficult to successfully trade in and out of, especially since our own emotions can play a huge role. The true power in stock market investing has been in taking a long-term mindset, setting a strategic allocation that fits your needs, and staying the course. This crisis has created a very swift dislocation, but the good news for a long-term investor is it creates an opportunity for higher future returns. While the news flow is focused on the sensational and the day-to-day, from an investment perspective, now is a great time to tune it out and think long-term.
1 Dalbar, “Quantitative Analysis of Investor Behavior”
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