Friday, August 7, 2020

The Number One Lesson (Re)learned from the COVID Correction/Recession

Discipline might be the most important and most difficult principle for investors to follow. While the coronavirus pandemic progressed, financial markets experienced unparalleled volatility as the world faced economic shutdowns designed to keep the virus from spreading. A natural and justified human reaction to the uncertainty is to protect and preserve the resources you have. While this might be the right strategy in some respects, staying disciplined and invested is consistently the most productive solution for long-term savings like retirement accounts which are designed to provide decades long retirement income stream.

The S&P 500 experienced the best 50 trading days in history as markets recovered from the March 2020 swoon. The S&P 500 increased by a historic 37% from late March into June. This was immediately preceded by the sharpest correction ever, falling 35% late February into March. Missing out on those 50 best days ever, or even a few of the really powerfully positive days, could have put your long-term retirement plans in jeopardy.

The chart below illustrates the intra-year declines experienced during each of the past 20 full calendar years. In 11 out of 20 years, the markets fell by at least 10% at some point during the year.

Source: Morningstar Direct, as of 12/31/2019. Indexes are unmanaged, do not incur management fees, costs, or expenses, and cannot be invested in directly. Past performance does not guarantee future results

Financial markets are nearly impossible to time exactly right because investor psychology is unpredictable. Additionally, the financial markets typically recover from a shock or economic setback before the data suggests the worst is over. For instance, stock markets bottomed in March of 2009 in the wake of the housing crisis before recovering over 60% by the end of 2009 – even as job losses continued, foreclosures accelerated, and real estate prices continued lower.

During a severe correction or crisis, it’s not uncommon for us to receive client requests to sell investments and then wait for the situation to stabilize and reinvest. There are a few problems with this strategy: First, when we get this request, the markets have almost assuredly already reflected at least some of the uncertainty, so we are selling after some or most of the decline has already been suffered. Second, if you are lucky enough to not be selling at the bottom, there is little chance investors are going to be courageous enough to reinvest as markets continue falling. There is, however, a good chance that by the time the environment has stabilized, stock prices will be higher – possibly significantly higher. We often ask our clients, “Do you think market prices will be higher or lower when you feel comfortable investing again?”

The data below illustrates the unpredictable duration of past corrections. In some ways, the stock market recovery this year also feels premature as the virus persists and layoffs continue. So, to those who wonder if there’s a playbook that works for all corrections, we would say probably not; the irregular durations of prior corrections and the difficulty timing them reflect otherwise.

In the wake of the pandemic there was a remarkably swift policy response, which served to reduce the magnitude and shorten the duration of the stock market correction. No question, markets have benefited from government stimulus in the form of loans to companies, extra unemployment payments, stimulus checks and the like. These government transfers helped bridge the economy through the economic shutdown much of the country experienced the past several months.

The fiscal actions of Congress and money policy responses by the Federal Reserve and how markets react to these policy responses are also challenging to forecast ahead of time. Financial markets have reacted incredibly favorably to the government financed response to the economic damage across the globe since March. While we don’t know exactly how the pandemic will progress over the following weeks and months, we believe focusing on a disciplined investment strategy while taking advantage of some of the evolving investible themes is likely to produce a winning result.

On that note, come visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.

Best Regards,
Edward J. Wilcox, CFA, CFP
Rollins Financial, Inc.

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