by Ian Breusch, CFA, Sanibel Captiva Trust Company Chief Investment Officer
Capital markets remain extremely volatile as the COVID-19 continues to spread across the globe. Now that COVID-19 is a global pandemic, we have seen an unprecedented level of cancellations over the last few days affecting travel, small community events, schools, sporting leagues, concerts, and other public gatherings of various sizes.
We learn more each day, but considerable unknowns remain. While we won’t have hard numbers to fall back on in the near term, we now expect the economic toll to be rather significant for many of our portfolio companies. It is quite likely at this point that we will experience a recession. Over the past 16 trading days (2/20/20 – 3/12/20) the stock market (S&P 500) has fallen by nearly 27%, which is a strong indication that market participants are also collectively anticipating a significant slowdown for some period of time.
Two of the most important members of OPEC, Saudi Arabia and Russia, were unable to come to an agreement on oil production cuts in early March, which has caused oil prices to fall dramatically at the same time that COVID-19 is gaining traction. While a resolution among OPEC remains important, we believe the COVID-19 pandemic is far more consequential to the broader global economy in the near term.
Given the backdrop of global concern and the remaining unknowns, it seems quite likely that volatility will continue for the foreseeable future. We expect the news to get worse before it gets better. Stock and bond market activity is often a leading indicator, meaning investors tend to react first and ask questions later. Although we have already experienced a significant sell-off in capital markets, we think it is possible for markets to continue to trend lower over the next several weeks.
Now that we have discussed the facts as we know them today, let’s discuss how investors should handle this period of time in the context of prudent long-term investment management. We recognize the past few weeks have caused many investors significant stress as they watch stock markets almost completely unwind the gains earned over the past year. This anxiety is only further exacerbated by the remaining unknowns still present. However, during periods of increased volatility or market decline, it is important for investors to “stay the course”. We make this statement in the face of all the risks and uncertainty we highlighted earlier. The two primary reasons we believe in staying the course through uncomfortable/stressful periods of time are listed below and we will unpack each common misconception using history as our guide. We recognize the unique nature of the COVID-19 pandemic and that every tumultuous period of time has its own unique characteristics and challenges. However, the way in which capital markets behave and respond to various crises is rather predictable.
1) Investors dramatically overestimate how long it takes to recover from significant downturns
The chart below shows several different periods of market disruption and subsequent returns after 1, 3, and 5 years. While the speed of recovery is different, the end result is clear – markets rebound to much higher levels after periods of market turmoil.
The next chart (below) reiterates the same point but instead shows market declines of 10%, 15%, and 20% over the past 90 years, and subsequent returns after those periods of market decline. Markets have averaged an annualized return of 9.6% immediately following periods of rapid market decline. The notion that it takes markets several years to rebound or that old age means we don’t have the time to recover from market turmoil is often completely incorrect and the data has proven this over many different periods of time under very different circumstances.
2) Investors overestimate the likelihood that they can sell and buy back in (time the market to avoid the stress) without permanently damaging their portfolios
The dangers associated with making hasty/emotional decisions in response to market turmoil is long term in nature. When we sell out of fear, to avoid the next leg down in markets, we often permanently damage the long-term prospects of our portfolios. It feels good in the short term to believe “we’ve stopped the bleeding,” but at what cost? The chart below reveals the damage done over long periods of time by not being invested on the best days of the market. Often times, the best days in the market come immediately following the largest downturns!
The financial crisis of 2008 highlights this point further. With the benefit of hindsight, we all recognize that investors weathered the financial crisis quite well assuming they remained invested throughout. The financial crisis was an extremely difficult time and it fully tested the resolve of even the most strident advocates of staying the course.
Though it is an extreme example, March of 2009 highlights the importance of staying the course particularly during volatile periods of time. Most of us agree that it is foolish to believe that anyone can perfectly time their movement in and out of equity markets to avoid losses and capture gains. However, the chart below shows that perfection is often required. The consequences of selling stock to avoid volatility can be disastrous for long-term investment results.
If an investor in 2008 or early 2009 chose to sell their stock and avoid volatility, would they have chosen the correct day (March 9, 2009) to reinvest? Despite the dramatic movements in day to day stock prices, the investor that stayed the course actually earned over 8.5% during March of 2009. Moreover, similar volatility ensued during April of 2009, ultimately leading to another 9.4% in price appreciation. In other words, the investor that sold their stock to avoid volatility would have missed out on price appreciation of 18.7% in two months. Considering the S&P 500 rose 26.5% during the whole year, if you were not invested in March or April, you missed out on the overwhelming majority of the rebound experienced in 2009. The next obvious question we must ask ourselves is: how many of us that sold out of fear were ready to reinvest in early March of 2009? If we’re honest with ourselves, the answer should be fairly obvious – not many!
We recognize the emotional response that significant market turmoil creates. These periods of time make all of us uncomfortable. However, the correct response is always to lean on the lessons of history and take action warranted by logic and reason – rather than raw emotion or fear. Your Portfolio Manager and Wealth Advocate are always available to help assuage those inevitable concerns. As always, we appreciate your continued confidence and we will work through this period of time together.