Time vs. Magnitude
The S&P 500, which is the generally accepted measure of U.S. stock performance, fell 33.9% in 33 days. February 19th was the all-time high for the S&P 500 and March 23rd is the current low. As of last night's close, the S&P 500 is 12.4% higher than it's March 23rd low. The magnitude of the sell-off is not without precedent. What is without precedent in the swiftness of the decline.
We’ve concluded that we can add more value by not focusing our thoughts on this horrendous virus, or more specifically, our expectations of its future path. As we've mentioned before, we are not virologists. That said, the foremost experts in virology originally believed this virus was not much worse than the common flu. The WHO (World Health Organization) communicated that the virus was “likely not transmittable between humans”. During January and the first half of February, we were told healthy people should not be overly concerned. By late February virologists forecasted up to 2.2 million U.S. deaths and an 80% domestic infection rate. The current forecast is between 100,000 and 240,000 domestic deaths and a single-digit infection rate. We are not pointing this out as a criticism of virologists, to the contrary, their work is saving millions of lives and for that we are incredibly grateful. We are explicitly pointing out the difficulty in forecasting this virus. Simply stated, if the duration and magnitude of this virus is worse than expected, markets will go down. Of course, the opposite is also true. As investors, we must accept reality and recognize the severely limited power we possess with regard to predicting these drastic, seemingly random events and their effects on the market. Much like market forecasts for the year 2001, which did not include any predictions of terrorist strikes, market forecasts for this current year, including ours, did not include any narrative surrounding a global pandemic. What we must also accept, however, is that enduring these events over shorter-term periods allows us to profit over the longer-term periods. The power of investing for the longer-term overwhelms the pitfalls of guessing what the short-term holds. We think an interesting exercise at this point is to go back and examine previous bear markets without regard for why they occurred, or why they eventually recovered. We simply looked at the magnitude and duration of the decline and recovery for each. Since WWII, there have been 12 bear markets. Ironically, the average bear market decline was 33% from peak to trough, the same as this current bear market. However, unlike this current bear market, the average drawdown (peak to trough) period was 14 months. This current bear market drawdown period was 33 days, by far the fastest. The average recovery (stocks regain the value lost in a bear market) period was 22 months. In previous bear markets, there has been a strong correlation between the duration of the drawdown and the duration of the recovery: The quicker the drawdown, the quicker the recovery. The magnitude of the drawdown has far less to do with the duration of the recovery period than how long the drawdown took.
Sound investment plans are designed to match the risk of an investor’s portfolio with the investor’s time horizon. The reason why structured long-term methodologies have been successful and short-term market timing has not been, is due to the far greater dependability and accuracy of longer-term forecasts vs. shorter-term forecasts. Short-term investors (traders) purchase stocks when times are good (prices are high) and sell stocks when times are tough (prices are low). Structured investors eliminate emotion by relying on the long-term averages of markets. We are less than 2 months into this bear market. Nobody with a 2-month investment horizon should have been invested in the stock market.
The following charts are important reminders why longer-term, properly diversified, investors fare better than short-term market traders. While investors should always be diversified, even investors with a 100% stock portfolio have not lost material value over a 5-year horizon.
US Stock Market Returns
An investor who simply puts 50% of his or her portfolio in stocks and 50% in bonds has never lost value over a 5-year period.
50% Stock - 50% Bond Portfolio
We realize it’s not as simple as telling investors they must wait this out. We also know it is not prudent, on the other hand, to overreact to headlines. Altering a long-term investment strategy due to fear would be counterproductive to your investment goals. Hindsight bias leads to the belief that external shocks to the economy are more predictable than they are, but our recollections are subjective and prone to revisionist history. Our point is simple and bears repeating, investors have virtually no explanatory power with regards to short-term market movements. The tendency in tough times like these is to react to the crisis of the moment while overlooking the resolution of prior periods of crisis. In addition to our next point also being simple and worth repeating, it is perhaps the most important point of all. Wealth accumulation has suffered far more from not being a participant in market appreciation than it has from enduring bear markets. The severity of the economic impact of COVID-19 is exceptional. It has shut down the majority of the U.S. economy. Our expectation, based on the consensus view of the medical experts is that within months, not years, it will no longer be necessary to practice the current extreme measures of social distancing. This gradual return to the norm will allow the economy to start reopening. While it will take a long time for the economy to fully recover, it will be growing again. Our belief is that the government will take the necessary steps to assure that we can "float" the economy until that time. It is difficult to say when stock markets will bottom out. Perhaps they already have. Either way, we expect markets will bottom out sooner rather than later. We also believe that as the economy recovers so will markets, though not as quickly as they declined. Our top priority is to make sure investors stick to their longer-term investment plan during this incredibly difficult and trying period. Our most important tool in accomplishing this goal is communication. Be safe, The GreenPort Team