When the history books are written, March 2020 will merit its own chapter. Maybe two. Lengthy chapters. Among other notable items, March 2020 will be remembered as the longest month on record. Officially, it measured 31 days. Unofficially, it lasted 97. So it felt.
In this forever-month, we witnessed the culmination of the longest bull market in history (132 months: March 2009 – March 2020), the fastest bear market in history (16 trading days: Feb 20 – March 12), and – by some measures – the shortest bear market in history (3 days: March 23 – 26).
On average, the twenty-five prior bear markets since 1928 have required 255 trading sessions to achieve the objective bear market requirement of a 20% decline from market peak. It bears (no pun intended) repeating – this one required just 16 days. Among other noteworthy items about the 16 trading days starting on February 20th is that three of the fifty best trading days since World War II came within this stretch (+4.9% on March 10, +4.6% on March 2, +4.2% on March 4). That means that to lose 26.7% over 16 days, the stock market needed to absorb three of its best days ever during the stretch.
Consider a few other metrics that help put the recent volatility in some historic perspective.
- The stretch between February 24 and April 6, 2020 accounted for 31 of the 18,759 trading days since World War II. In those 31 days, the stock market (S&P 500 Index) experienced 9 of its 100 best days since World War II and 11 of its 100 worst days.
- One way to compare volatility for a month is by taking the absolute value of each daily return and adding them together. Do that for March 2020 and you get a result of 109% – an average movement of 5.0% per day. By this measure, March 2020 goes down as the most volatile month ever and it’s not even close. The 5.0% average daily move is 28.2% higher than the previous record set in November 1929.
We can go on about the historic volatility or the Q1 market experience but instead choose to reflect on eight important lessons from this unprecedented environment that we can all appreciate, remember, and follow so as to be better investors in the future.
1) We never repeat the same crisis. This time is always different.
You have heard and will undoubtedly again hear how this crisis is different than any crisis in the past. It most assuredly is. It is historic. The abruptness of this economic contraction is unprecedented. The unemployment claim numbers over the past three weeks – nearly 17 million in total – provide shocking evidence.
Now pause for a moment to consider a sampling of some crises over the past 30 years: September 11th, the financial crisis, the European sovereign debt crisis, the Russian default crisis, the Asian currency crisis, the Gulf War, the Flash Crash, the Fiscal Cliff, Y2K, the dot.com crash, Brexit, Fukushima, Katrina, and two impeachments. To name a few. They were all different.
Yet while all crises are different, they ALL have the same four common denominators:
- When we are in the middle of each crisis, things are scary. Often, very scary. And uncertain.
- In every crisis, there are purported experts – plenty of them – opining on how bad it’s going to get. And because pessimism sells, they are overwhelmingly given airtime and megaphones to do so.
- Every crisis eventually winds down, economies grow, corporate profits return to pre-crisis levels, the stock market fully recovers, and life returns to normal.
- A few years removed from each crisis, our hindsight fools us into underappreciating how uncertain it was when we were in it and misremembering how obvious it was that we would get past it.
2) The stock market does not need good news to rally. It just needs a less bad future than was expected yesterday.
Consider that the S&P 500 just completed its best week since 1974 – posting a +12.1% return in the shortened trading week ending April 9th. To be clear, 16.8 million Americans filed initial unemployment claims over the past three weeks and the domestic stock market recorded its best week in 46 years. Including the two prior weeks, the S&P 500 is up 24.7% from its lows.
In the course of this dramatic 3-week rally, I heard several variations of the following:
“I do not understand why the stock market is rallying. This Covid-19 pandemic is going to get a lot worse. The resurging market fails to appreciate that many more businesses are going to go bankrupt, that the parabolic rise in Covid-19 deaths is going to continue, that the horrendous unemployment numbers will get worse, and that this will be a historically bad economic downturn like none other. The stock market rallying in light of all this seems foolish.”
Make no mistake – we are in the most telegraphed recession in history. It will not be official for several quarters to come but the stock market knows this is more than a garden variety contraction. And while few, if any, saw this pandemic coming at the start of the year, it is not a secret now. The stock market is well attuned to the dramatic economic impact that this pandemic will have.
Importantly, the stock market reflects the present value of anticipated future corporate profits. The S&P 500 Index, for example, reflects the expected future profits of large companies such as Apple, Walmart, AT&T, Microsoft, Google, and Proctor & Gamble discounted back at a reasonable discount rate. A simpler way of reflecting this is the following formula:
Stock Market Value = Future Corporate Profits / Uncertainty
When the S&P 500 fell by 34% this year, it was the result of reduced corporate profit expectations (lower numerator) in the future and high uncertainty about the future (higher denominator). That move was the stock market factoring in all the bad stuff – the Covid-19 deaths, the bankruptcies, the job losses, the future uncertainty.
But the stock market moves higher when one or both of two things happens: the expectation for future corporate profits increases and/or uncertainty decreases. The global impact of quarantines and social distancing to slow the spread of coronavirus did not eliminate uncertainty but it did reduce the enormous range of likely outcomes, thereby reducing uncertainty. Moreover, actions by global central banks to strengthen credit markets and unprecedented fiscal spending helped to reduce the chances of a more severe depression both helped to reduce uncertainty about the future. And the stock market just needed less uncertainty to move higher – which it got. Still really high uncertainty – just a little less uncertainty.
3) The market knows more and is more forward-looking than investors give it credit.
Public backlash arose when reports surfaced that members of Congress profited based on their unique knowledge of the coronavirus pandemic. These Congressional members were briefed by intelligence officials on the severity of the impending crisis in early February and immediately engaged in aggressive stock sales, collectively selling millions of dollars of stock before the public was aware of how severe the coronavirus crisis would become.
While Congressional members taking such action while simultaneously communicating to the public that the coronavirus would not pose a massive health risk in the United States was undeniably wrong, there’s another important takeaway: the stock market reflects far more information than individual investors know or appreciate.
Congressional members were not the only ones who had access to unique information about the likely impact or spread of Covid-19. So did scientists studying the epidemic around the globe. So did the Chinese government. So did European governments. So did institutional investors paying millions of dollars to get earlier access to information and better information than you.
Maybe the important lesson here is that you’re always at a disadvantage. Arguably, the better takeaway is to eat a piece of humble pie and appreciate the idea that any of us knowing as much or more than the market is almost always a fallacy.
4) Making market predictions is easy. Getting them consistently right is difficult, if not impossible. Following them is foolish.
Even if you are able to predict how the future unfolds for this pandemic, you still have to determine how Congress will respond, how the Federal Reserve will respond, how the President will respond, how global central banks will respond, and lastly, how market participants will react. Getting some of those predictions right, but not others, may be more destructive than helpful.
The next time that you find yourself puzzled as to why the market went up or down today based on specific news that seems antithetical to the latest market response, remember lessons 2 and 3. But also remember the paragraph above and that it’s about far more than today’s headline.
5) Stocks provide a higher long-term return because the market compensates equity investors for bearing the risk of stocks and enduring the volatility.
Unfortunately, stocks go down and sometimes they go down by scary amounts. The month of March represented what the risk of equity investing looks like. Without this risk, there would be no greater return from stocks than from cash. This is called the equity risk premium.
And because risk is elevated now, so is the equity risk premium. It’s like wind insurance after a hurricane – premiums instantly increase providing a higher expected return for the insurer (risk-taker) and a more negative return for the insurance purchasers (risk-seller). That’s where we are with the equity market now – there’s a higher expected return for buyers/owners than there was at the onset of 2020 because there is a higher equity risk premium.
Furthermore, this is why disciplined rebalancing works. It contra-trades relative to our emotions. Rebalancing inherently reduces risk when risk premiums are low (fear is low) and adds risk when risk premiums are high (fear is high). And where do the profits from rebalancing come? From the bulk of individual investors who do the opposite – trade based on emotions (buying when perceived risk is low, selling when perceived risk is high) rather than trading based on a discipline.
6) Making extreme portfolio changes or bets is not investing. It’s gambling.
When you’re an investor faced with many unknowns – which encompasses every day since the beginning of time – it is better to focus on what is probable rather than what is possible. Loading up on beaten-down airline stocks and selling 100% of a portfolio to cash both reflect binary outcome bets that draw analogy to playing craps in Las Vegas. Entertaining? Perhaps. Consistently profitable? Unlikely.
The lesson to draw from every market reversal is that investors should embrace the uncertainty of markets – not just in good times, but also in bad. Embracing that uncertainty means that the best approach is constructing a portfolio of diversified assets. It means setting an appropriate risk level, establishing a discipline based on that risk level, and then consistently maintaining it. In short, it means preparing for all possibilities – not just one possibility. That’s true when markets are going up just as much as when markets are going down.
The best advice for investors who feel the desire to gamble? Do it in small chunks with gambles that won’t noticeably impact your financial plan.
7) Market reversals are often fast and not telegraphed.
On March 22, a long-time client forwarded me an article from a major news publication with advice from financial advisors on how to handle the crisis. In this article, one of the “expert advisors” suggested that she was “waiting for more certainty before buying” and that “volatility won’t be over until we’re finished with this virus”. I informally responded:
“God bless this advisor and her clients. It’s naïve and/or incompetent to suggest that there is going to be a time to buy when we have more certainty. When we have certainty, it will be the first time that we’ve ever had certainty in the history of financial markets. When we have more clarity, the stock market will likely have recovered all that it’s going to have recovered and anyone waiting to invest will get much lower expected future returns. There will be uncertainty related to this virus for many months and then there will be some other uncertainty that we don’t even know about right now. And the market pays investors for uncertainty, not for certainty. But let’s be thankful for this kind of advisor because her and her clients are the ones who transfer their wealth to the rest of the investors in the market.”
Over the next 13 trading sessions, the S&P 500 increased by 24.6% – a reasonable return for 3-5 years, let alone 13 days. For historical context, quick reversals from sharp market selloffs also occurred in 2009, in 2003, in 2011, and in 1987. Going to cash to wait for more clarity or for a “clear market bottom” may feel appropriate but has historically meant losing several years’ worth of returns when the market eventually reverses.
8) We would all be better served to divert our energy and time to controlling the controllables.
There will always be stories of investors who sold everything at the top or bought aggressively at the extreme bottom. What will not be reported is the seven times before when they sold prematurely and sat mostly in cash during a market rally. That is not newsworthy and even if it was, no investor is going to the media to tell that story. The commonality of nearly all successful investors is that they took a disciplined approach, not that they were consistently prescient in nailing the top and the bottom.
The path to financial success is to largely ignore what you cannot control (the stock market, politics, interest rates, economic data, etc.) and focus on what you can control (budgeting, rebalancing, saving, tax planning, estate planning, strategic asset allocation, etc.). From a non-financial perspective, we can further help ourselves by focusing on what we can control right now: following CDC guidelines, enjoying quality time with our families, healthy eating, exercise, leveraging technology to check on friends, and limiting our diet of news from all sources.
Participate in the financial markets long enough and there will be challenges and crises – plenty of them. If we’re humble about what we know and don’t know, if we learn from the past, if we appreciate the investment markets for what they are, if we appreciate the differences and commonalities of each crisis, and if we control what we can control, then we will be better for it – financially and emotionally.