If you drive a vehicle, you expose yourself to a great deal of risk every time you slide behind the wheel. Whether it be a short jaunt to the grocery store, a longer trip to grandma’s house, or a weeklong road trip, drivers are always at risk of a car accident.
But if it’s been a long time since you found yourself involved in an accident, it’s easy to forget the risk you take every time you drive. More times than not, we safely get to where we need to go.
But occasionally, we realize the risk and accidents do occur. Sometimes they’re minor… other times, they’re significant.
Accidents Happen, on the Road… and in Your Portfolio
You also face risk every day you hold investments in the market, no matter what your specific asset allocation looks like and even if you don’t realize that risk with an “accident” very often.
Collectively, we’ve gone a very long time since we’ve found ourselves involved in a market accident. After a record-setting bull market that nearly lasted 11 years where the S&P 500 rose 500%,1 it’s hard to fault any investor who forgot the real risks we took daily during this time.
But now, the reality of risk is here. The market run seems to finally be over, and we’re all facing what feels like a very uncertain future.
The Impact of a Global Pandemic on Financial Markets
What caused the end of this bull market was not your standard asset bubble going bust, or a dramatic increase in inflation or interest rates. Instead, this havoc was caused by the novel coronavirus that began spreading in China in December of 2019.
The U.S. market didn’t flinch as this event unfolded across the globe. In the beginning of 2020, it picked up where it left off in 2019: climbing higher in January and hitting its peak on February 19th.
But we quickly got our reality check the following week. The S&P 500 fell by 10% in a week for the first time since 2008 as the coronavirus spread, the World Health Organization declared a pandemic, and investors grasped not only the risk to public health but to the entire global economy.
Uncertainty Breeds Volatility
Unfortunately, the panic didn’t end there. The S&P set a record for the shortest time between a new market high and the start of a bear market (defined by decline of 20% or more). The market would fall by more than 30% before a brief rally at the end of the quarter.
The ultimate result? A 20% loss in the S&P 500 — its largest quarterly loss since 2008.
A major contributor to the rapid market sell-off was the amount of uncertainty that the coronavirus created in regards to the global economy. We know markets dislike bad news — but they loathe uncertainty.
There is much we still don’t know, including how many people will ultimately become infected with the virus, when the virus’s growth rate will peak nationwide, and how long it will be until we can return to some kind of normalcy.
It’s this last unknown that creates the biggest challenges for investors. 70% of the U.S. economy is made up of consumer spending — and right now, most consumers are cooped up at home, unable to spend as they normally would.
This rapid decline in spending means companies face significant challenges just to survive, let alone make profits for their investors.
Given the answers to the unknowns continue to evade us, investors should brace for continued market volatility as participants search for clues about when the economy can return to a more normal state and how that might impact various industry sectors and companies.
The Government Opts for a Bazooka Over a BB Gun
The stock market’s steep decline should come as no surprise given the coinciding spike in unemployment with the economy coming to a grinding halt. What helped stocks rally in late March was the strong policy response by the federal government.
The Federal Reserve became the first to act with monetary policy support, slashing the Fed funds rate to 0%. They also increased lending capabilities for banks and committed to further bond buying to help stabilize financial markets.
The federal government then followed up with a $2.2 trillion stimulus package. The relief included direct payments to individuals, loans to small businesses, and further aid for the hardest-hit industries.
The amount of aid provided in response to the economic impact of the pandemic is the largest we’ve seen since the Great Depression (as a percentage of GDP). It seems the government has learned from past recessions where relief efforts were slow and done piecemeal over time, which may have prolonged the downturn.
Of course, this is deficit spending at work — and that means there may be consequences to the government’s spending down the road. However, when putting out a burning fire one can’t worry about the risk of smoke damage.
Should You Wait for the Economy to Recover to Invest?
Some investors may be tempted to play the waiting game, holding off on continued participation in the market until the economy recovers. We would caution against such a strategy for several reasons.
Market timing is nearly impossible to do — and one must do it correctly not once but twice. You have to know when to get out of the market as well as when to get back in at the correct times.
Research also shows that some of the biggest market up days happen around the biggest down days. Investors timing the market risk missing the best market days. We saw this play out several weeks ago with the Dow index having an 11% gain in a single day, its best since 1933.
Finally, in looking at historical recessions, the stock market recovers before the economy an overwhelming majority of the time. In our last recession, the stock market bottomed on March 9th, 2009 despite the recession not ending until July 2009. Over those 4 months, the S&P index was up 36%.2
If you wait until you feel better about the economy, you will likely miss out on the recovery and upward swing that already happened in the market.
A Risk Worth Taking
In 2017, there were more than 6 million car accidents in the U.S. and 37,000 fatalities. And yet most of us still take the risk of driving our cars daily because we deem the benefits of travelling to be worth the risk of an accident.
When it comes to our investments, the trade-offs are similar. We choose to invest despite the risk of periodic market accidents, because the benefits of achieving our financial goals over the long-run exceeds the risk of periodic market accidents.
While the decline in the stock market is painful to watch and experience, it also presents the opportunity to invest at prices we haven’t seen since 2018. Whether it be putting some idle cash to work or funding a retirement plan for 2020, now could be a good time for long-term investors to create a systematic plan to not just continue their contributions, but to increase them.
By making sure we own a diversified balance of stocks and bonds, rebalance our portfolios as necessary, and aligning the risk we could realize in our portfolio with the amount of risk we can tolerate, investors give themselves the best chance of minimizing those periodic accidents and achieving their long-term financial goals.
Source: 1,2 Morningstar