Gaining the Right Perspective in Uncertain Times

The worldwide coronavirus outbreak has caused a very sharp downturn in the economy and world equity markets. Unlike the financial crisis of 2008 and 2009, this “perfect storm” was not created by human excess, but an unforeseen health event – a pandemic. As we noted in our last piece, we came into this crisis with the economy on rather strong footing. 

While no two downturns have been exactly alike, we want to offer some context and how it relates to your investment plan. Specifically, we’ll outline what, if anything, you should be doing now with your portfolio. 

The Recovery is Expected to be Swift

We believe the economy will make progress in relatively short order once headway is made on the health front. Containing the pandemic and mitigating losses is no small feat so we don’t mean to sound dismissive, but our base case is a robust economic recovery once that happens.

The Speed of This

You probably don’t need us to tell you that the longest bull market in history just turned into the fastest bear market in history. It took only 16 trading days for the market to drop 20% and only 22 days to reach a 30% drop.

It would be completely normal to feel uneasy about this. 

The 3-Legged Stool of Economic Recovery

We believe that getting the economy back on solid footing will depend on the strength of three pillars - a three-legged stool of recovery. Two of the three are now firmly in place.

1. The first is Monetary Stimulus – the Federal Reserve.

The Fed has acted decisively, quickly, and powerfully by reducing short-term interest rates to zero. They’ve committing to injecting a seemingly unlimited amount of capital into the system to keep it running smoothly. 

This stimulus is historic in size and unprecedented in speed. You could say the Fed is throwing the kitchen sink at this. 

2. The second leg of the stool is Fiscal Stimulus - Congress. 

Yesterday, our elected officials hammered out a deal on a projected $2 trillion relief package. The package includes getting real cash into the hands of Americans within the next few weeks. Individuals will receive $1,200, while joint filers will receive $2,400. In addition, taxpayers will receive $500 per child 16 and under. This is means tested, however, with complete phase out for single filers at $99,000 of AGI on the 2018 tax return, or $198,000 for joint filers.

There is a provision in the bill which includes a new exception to the 10% early distribution penalty from IRAs or 401(k)s for COVID-19 related disruptions. 

Student loan payments are suspended for Federal loans through 9/20/2020 and no interest will accrue.

There’s also support in here for large businesses, small businesses, the health care system, and those on unemployment. You can read more here. 

3. The third leg is Health Crisis Improvement – Medical Care and Science.

We need to see improvement in at least one of these areas – but all would be preferable.

First, are adequate testing and social distancing measures flattening out the curve here in the US as it has in China and South Korea?

Second, are researchers, scientists, and doctors finding success in treating those with the disease?

There are a few promising treatments, such as the drugs Remdesivir and Favipiravir, as well as the combo of Chloroquine and Azithromycin. As we noted it our last post, it’s way too early to tell whether any of these are truly effective, and vaccines take significant time to test, come to market, and then reach widespread availability.

 A vaccine would be the best possible news, however that doesn’t seem likely until sometime next year.

Characteristics of Bear Markets

It’s instructive to look at the last month in the context of history. All bear markets are scary. But downturns and recoveries are more common than you may think. 

The chart below shows the previous 11 bear markets since 1929. A bear market is defined as a decline of 20% or more in the US stock market. 

As you can see, recessions and accompanying stock market declines are not new. In fact, these declines are a normal part of the economic cycle. What’s most important to pay attention to is that the average length of a bear market has been 22 months with a magnitude of -42%. 

The current bear is now in its second month and, while we’ve rebounded this week, has delivered a max drawdown so far of about 34%.

Characteristics of Bull Markets

Here we see the flip side. These are all the Bull markets since the early 1920s. A bull market is defined as the length of an expansion without seeing a 20% or greater downturn. 

Bull markets have historically lasted twice the length of bears at 54 months while delivering a higher magnitude upside with an average return of +161%.

 Stocks, Bonds, Bills and Inflation

Looking at this graphically, you see bear markets and sharp downturns are a normal part of the investment cycle. Looking at it this way, we see how this applies to your investment plans. 

Between 1926 and 2019 stock investments demonstrated the most risk, meaning they exhibited the most variability in their day-to-day and year to year returns, but they’re also the investments that have historically produced the highest return over time.

Large cap stocks produced an average annual return through all the ups and downs of 10.2%. Even with those 11 major Bear markets, stocks produced the highest return over time. 

Investors take this risk because they want their long-term money to grow. They want to build an account large enough to generate their target retirement income need. 

You can see that it would have been much safer to invest in government T-bills (essentially savings/money markets) or government bonds, but the returns have been barley enough to beat back inflation. If you want to dig a bit deeper, I’ve discussed this is greater detail in our piece, “Where Do You Want Your Risk.”

The Cost of Market-Timing

The best thing you can do now is to be patient.

In the face of economic and market uncertainty, the temptation to act for the sake of action can be strong. When asked what investors should do during downturns, Jack Bogle, the famed founder of Vanguard said, “While the interests of the business are served by the aphorism 'Don't just stand there. Do something!' the interests of investors are served by an approach that is its diametrical opposite: 'Don't do something. Just stand there!'" 

Market timing just means that you take action during volatile times and decide to sell all of your holdings, hoping to buy them back when the dust settles. It’s nice in theory but rarely works out that way, and is actually proven to harm returns. 

Using data for the 20 years ending 2019, by staying invested in stocks for all 5,035 trading days an investor would have achieved an average return of 6.1%.

But what if you just missed the 10 best days – the 10 best days out of 5,035 trading days?

Your return would be diminished from 6.1% per year to just 2.4% per year. 

Ironically, the best days are typically clustered next to the worst days. 

This week is a great example. After hitting a three year low on Monday, US stocks rebounded 20% in just three trading days.

Miss the best 20 days? You would have basically given up almost all the return.

Another way to look at this period of time is opportunistically. If you have time between now and retirement and you’re still able to make regular contributions, you are buying now at a discount compared to just a month ago, allowing you to accumulate more shares at cheaper prices.

Although we’ve spent our time discussing US stocks, here, we believe that diversification among global stocks and bonds, matched to an investor’s unique goals and tolerance for risk, remains the optimal approach. 

As always, we’re here for you. We love speaking with you. Please reach out or use this link to schedule a call.

Brian

Boyd Wealth Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.