In attempting to describe the last month, we quickly run out of superlatives. Unprecedented. Painful. Surreal. Historic. Stressful. Volatile. Scary. Unreal. We saw a new virus engulf the world in a global pandemic, with elected leaders at first calling it a hoax then declaring a national emergency the next day.
From a societal standpoint, the coronavirus has upended life as we know it. As of this writing, more than a dozen states have instituted ‘stay-at-home’ orders with tens of millions of Americans working from home and practicing social distancing.
The short-term impact on the global economy will assuredly be detrimental, and all sorts of markets have experienced unprecedented volatility and downward pressure on asset prices. The oil market suffered its single worst day since the Kuwait invasion thirty years ago, with oil now trading under $25 per barrel after trading above $50 per barrel just one month ago. The bond market saw 10-year Treasury bonds yielding below 0.4%, a level not seen since … ever. Let that sink in for a second. Would you ever lend money—to anyone—for ten years at an interest rate of just 0.4%? The stock market did not fail to play its part in the panic, entering a bear market in record time. While it typically takes eight months for stocks to enter a bear market—commonly defined as a decline of 20% from the most recent peak—this time around it took three weeks.
The Federal Reserve moved swiftly and decisively, at first lowering its benchmark interest rate from 1.5% to 1.0% in early March, then cutting it again a week later to effectively zero. Following several other interim actions, on March 23 the Fed announced basically unlimited quantitative easing. In 2008-09, the first rounds of quantitative easing allowed the Federal Reserve to purchase certain amounts of assets. The first couple of rounds were targeted at $600 billion. This latest round of easing has no such limit. Congress, for its part, passed the greatest bailout in the history of the republic, worth $2 trillion, providing desperately needed funds to some of the hardest-hit Americans.
Some Perspective on Market Downturns
If your knowledge of stock market history only extends back about a decade, until recently you may have thought that the only direction that stock prices are allowed to move is upward. However, if you take a longer view of things, you will quickly be disabused of that notion. Here is a chart of the 9 most memorable setbacks for U.S. stocks over the last 60 years:
Description |
Peak |
Trough |
Decline |
5-Year Return |
Cuban Missile Crisis |
Dec 1961 |
Oct 1962 |
-24% |
+108% |
Recession |
Nov 1968 |
May 1970 |
-33% |
+56% |
Oil Shock |
Jan 1973 |
Oct 1974 |
-45% |
+121% |
Recession |
Nov 1980 |
Aug 1982 |
-20% |
+297% |
’87 Crash |
Aug 1987 |
Oct 1987 |
-33% |
+118% |
Iraq War |
Jul 1990 |
Oct 1990 |
-18% |
+128% |
Asian Contagion |
Jul 1998 |
Aug 1998 |
-19% |
+13% |
.com Bubble & 9/11 |
Sep 2000 |
Oct 2002 |
-47% |
+121% |
Global Fin’l Crisis |
Oct 2007 |
Mar 2009 |
-55% |
+209% |
Average |
|
|
-33% |
+130% |
COVID-19 |
Feb 2020 |
Mar 2020? |
-34%? |
??? |
source: Yahoo! Finance, Inkwell analysis
These nine drawdowns were all instigated by distinct exogenous events. They each lasted a distinct length of time from peak to trough. They each experienced a unique percentage decline, and they each experienced a unique recovery trajectory.
The one thing they all have in common, though, is that in each of the 9 instances the market did eventually recover. The average recovery was to the tune of 130%, which is slightly more than a double. For stock investors who are able to hang on until March 2025, history seems to indicate that they will be rewarded for their patience.
But we’d like to make one important caveat about this chart. On the bottom row, we put “Mar 2020?” and “-34%?” as the trough level of the current downturn, but that’s only because it’s true as of the time of this writing. In the next few weeks, the news about the coronavirus will get much worse before it gets better. Many more people will test positive for the virus, many more people will die because of it, and there is still much darkness to come before the dawn.
As this news hits the airwaves, for all we know the stock market may take another tumble and go lower than it did in March. Or, again for all we know, the market may already be anticipating all of that bad news, and the lowest point will eventually prove to have been reached in March. It is very hard—impossible, we think—to play that particular guessing game.
A Few Good Days is all it Takes
But what about the idea that an investor would be better to sell everything near the top, wait for the dust to settle, and then buy back in to the market near the bottom? Well, as for selling everything near the top, one would need a time machine to be able to accomplish that. But now that we are where we are, should an investor try to get out and then get back in once the coast is clear?
JP Morgan recently did a study of what an investor would have earned by investing in the S&P 500 index over a 20-year period. The answer was a respectable annualized return of 9.85%. An initial investment of $10,000 would have become $65,453. However, if that hypothetical investor had missed out on the 10 best days—just 10 days!—over that 20-year period, her return would have shrunk to 6.10% and her $10,000 would have grown to only $32,665. Her portfolio would only have been half as big as it would have been if she had remained fully invested through all the ups and downs.
As the chart below notes, many of the market’s best up days occur in the midst of severe declines. We all experienced this first-hand when the S&P 500 advanced nearly 10% on March 24, its largest one-day gain since 1933. It’s days like that which really help a portfolio to grow over the long term.
source: JP Morgan Asset Management
In situations like this we always find solace in going to the words of Warren Buffett, which remind us how to react to wild fluctuations in the stock market. He said it best in his 1987 letter to shareholders:
Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.
...[A]n investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben's Mr. Market concept firmly in mind.
Mr. Market is depressed, indeed. Will you take advantage of him? We think you probably should.
Felipe Garcia, CFA and Aaron Byrd, CFA are co-founders of Inkwell Capital LLC (www.inkwellcapital.com), a registered investment adviser which provides discretionary portfolio management services to individuals and institutions.
