Well, things escalated quickly.
The world is watching as more information comes out on the
spread of coronavirus, and financial markets took notice. As of Friday’s close
both the S&P 500 (large US stocks) and the Russell 2000 (small US stocks)
declined over 12% from their highs. We saw similar declines across the world.
While it’s impossible to name one exact reason for stock market declines, it’s
obvious the impact of the coronavirus is being priced in.
So, what does this mean for our portfolios? What should we
do?
1. Remember that markets are absorbing all known information.
This is what’s actually happening. This is why stock
prices are declining in value. Each day, investors all over the world are
incorporating all known information into the prices of these investments – this
is how financial markets work.
Owning stocks – shares of businesses – means you own a right to the future earnings of those businesses. If earnings are expected to go up in the near future, you would likely pay more for a business (price goes up). If you expect earnings to go down in the near future, you would pay less for a business.
It seems logical that coronavirus is causing, and will
likely cause, lower earnings for businesses in the near future. People are
staying home. Manufacturers are adjusting production. People aren’t buying or
travelling as much. Tourist destinations, schools, stores, and churches are
closed. And we don’t know how long this will last.
In light of that, it seems logical that prices should
decline. There’s more uncertainty about future earnings of businesses
worldwide. However, this risk of short-term declines is a part of business
ownership. It’s the price we pay for higher long-term expected returns.
This also means we don’t have information to take advantage
of yet. We can’t time markets or make serious trading decisions based on recent
news – it’s already baked into stock prices.
2. Remember your financial plan and time horizon.
It’s completely natural to be concerned or anxious during
quick declines and news of spreading sickness. The important part is how we
react.
Your financial plan and time horizon should guide your
decisions. Remember the goals you set for your investments. It’s in light of
these goals that you selected your long-term mix of stocks, bonds, real estate,
etc. Your investment plan should change based on the changes in your goals and
life, not on short-term market swings.
Are you investing for 10, 20, or 30+ years? If so, this will
be a blip on the radar. Your concern is the returns over the coming decades,
rather than the coming weeks. In fact, the investments you’ve been buying have
suddenly gone on sale! It’s a bargain, and your future self will
thank you for staying invested.
3. Remember that this is considered….normal?
That’s right, stocks have declined over 12% and we would
consider this a normal year.
How so?
As JP Morgan shows in their annual Guide to the Markets, the
S&P 500 had positive returns 30 of the last 40 years. However, there was an
average decline within each year of 13.8%. We should expect that,
at some point within each year for whatever variety of reasons, there will be a
decline in stock prices.
The most recent major decline was the end of 2018 (20%!),
and that’s likely been long forgotten by most of us.
That doesn’t make this easier to stomach. But it should help
to know what we’re seeing now is par for the course, historically. There is
risk with owning stocks. Again, that’s that short-term cost we pay for higher
longer-term expected returns.
4. Remember that you may own bonds.
If you’re closer or
into retirement, or nearing any financial goal, it’s likely you own bonds in
your portfolio. Recent events are a great example of why diversification is
important, as there’s a good chance those bonds have increased in value.
This is the ballast of your portfolio – the point of
stability. You can rely on these relatively stable bonds during times of stock
declines and allow your stocks to recover. You can also use bonds to rebalance
into stocks, if it makes sense.
5. Remember that markets reward discipline.
It’s not easy
to go through times like this, but markets have always rewarded those who are
patient and disciplined over long periods of time.
As we can see from the graph below, there have always been
reasons to panic and run. We’ve seen an oil crisis, conflicts overseas, political
turmoil, a tech bubble, and a Great Recession. We’ve seen the spread of other
diseases. Before all of that, we saw two World Wars and a Great Depression.
Through all of that, those who are able to work through the fear and remain
invested were rewarded with long-term market returns. This is the outlook we
maintain – “this too shall pass.”
What to do
What are we doing during this time?
We are not making material changes to investment portfolios.
We’re monitoring the situation, and looking for opportunities to rebalance.
That is, sell the investments that have gone higher than we target in our
allocations (for example, bonds), and buy the things that have gone lower (for
example, stocks). This is systematically selling high and buying low.
Keeping a long-term outlook and maintaining discipline
through anxious times is difficult. But we believe in long-term investment in
businesses worldwide and human ingenuity. We don’t know how much further stock
prices decline or how long before the new virus feels contained. We don’t know
how the upcoming presidential election ends.
The good news is we don’t need to - we know businesses will
respond. They’ll trim costs, reevaluate supply and manufacturing chains,
improve their processes for similar events.
Our long-term outlook is one of positivity, and those able
to maintain their discipline will be rewarded over time.
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| Pathways Advisory Group, Inc. Evon Mendrin, CFP® |
Find Evon on
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