To remove any doubt, I claim no unique expertise in viruses, pandemics, or COVID-19, specifically. I am not going to cite R0 transmission rates or reference virus mortality rates to appear well-versed on pandemics and make predictions about where stocks are going next. Nevertheless, I will share a few comments regarding the recent stock market volatility, which is a decided reaction to the perceived threat of a global pandemic.
First, this is the obligatory reminder that stock market volatility is normal. Stocks go up. And down. Extended periods of calm as we enjoyed throughout 2019 do not change the fact that stocks have higher expected returns because they bear additional risk. It is reasonable to be frustrated by market volatility but we should not be surprised by it. The financial services industry is overwhelmingly littered with disingenuous fortune tellers making people think that they can avoid uncertainty that cannot be avoided.
Second, assessing whether the recent market volatility is an overreaction or an underreaction to the coronavirus requires advance knowledge of how widespread the epidemic will become and the resulting economic impact. If COVID-19 ends up as a global pandemic that causes hundreds of millions of people to stop travelling, eating out, shopping, or going to work for an extended time period, then the recent market selloff is likely just the beginning of a larger stock market selloff. If, however, the epidemic plays out much like scares of the past such as bird flu in 1997, SARS in 2002, swine flu in 2009, or Ebola in 2014 and is eventually contained without long-term economic impact outside of a few countries, then the recent selloff is just another market overaction and a buying opportunity.
Is this an overreaction? Maybe. Maybe not. Any “investment expert” who suggests with confidence right now that the market is overreacting or underreacting to the coronavirus epidemic is blatantly fooling themselves and/or misleading anyone who listens to them. What we know is that investors tend to overreact to negative risks. Not always – but most of the time. Bad news just gets amplified far more loudly than good news. So purely from a probabilistic perspective, scares tend to result in overreaction. But that doesn’t make this scare an overreaction. It just makes it more likely to be one.
Third, we should pay homage to and learn from history. History teaches us that the stock market rewards patience. It rewards discipline. It rewards long-term perspective. Those rewards are paid for by the impatient, by the undisciplined, and by the short-term investors. The market transfers wealth from individuals who wait on the sidelines “for things to calm down” to investors who stay disciplined. Investing in the stock market is not a free lunch and it is the scary periods that provide the reward for the disciplined investors.
Fourth, most investors do not care about diversification and high-grade bonds and rebalancing and uncorrelated investments and maintaining an appropriate risk level when the market is going up. If we are being honest, all of those things are boring and frustrating when the market is advancing. But these same concepts are the hallmarks of a strong investment approach and they earn their value during periods of heightened market stress such as these past two days.
As always, comments, questions, or concerns are welcome and can be posted in the comments section below.