The novel coronavirus, now named COVID-19, has been causing fear and panic around the world, not to mention wreaking havoc on the stock market. Given the virus is no longer contained within Asia and is poised to be a global pandemic, the ramifications on the stock market (which is always forward looking) have been extremely negative. As of Friday, 2/28, the Standard & Poor’s 500 (S&P 500) dropped approximately 300 points or 9% year-to-date. From the peak of the stock market in mid-February, the S&P 500 is down over 430 points or nearly 13%, officially putting us in “correction” territory.[i]
Looking back to the 2000s, we had three health epidemics that also came out of China; SARS, avian flu, and the swine flu. The average S&P 500 stock market drop due to these diseases was 15%. However, a year later, the S&P 500 was up an average of 25%. Similarly, with the Ebola virus and Zika virus, the S&P 500 dropped a lesser 10% and rebounded 14% thereafter. This could hint we have more downside to come.
The decline in the stock market over the last week has proven to be the fastest drop in history, according to Deutsche Bank Securities. There have been 27 market corrections since World War II, but the average decline of 14% was spread out over a window of four months.[ii] Some feel the rapid decline was due to the fact that stock valuations have been at their highest since 2002, making the market ultra-sensitive to a geo-political element like COVID-19.
We have been at the end of the longest Bull Run in the history of the stock market for years. In fact, economists predicted the end of the growth market cycle in 2018. However the Tax Cuts & Jobs Act became effective in 2018, giving corporations a 14% tax cut, or a synthetic boost to their bottom line that kept the stock prices buoyant. In 2019, Fed Chairman, Jerome Powell, initiated three interest rate cuts which eased monetary supply and boosted the stock market further. For two years, the market stayed artificially high, even though it was apparent the economy was slowing. As a result, stock traders have been skittish, constantly waiting for the other shoe to drop. This relentless unsettled feeling has coined our last market surge as the Most Hated Bull Run in the history of the stock market.
COVID-19 may be the catalyst to initiate the overdue market contraction the government has been trying to delay. We’ve never seen the market decline so rapidly due to a medical epidemic alone. To substantiate that, the declines we’re seeing in the stock market are not limited to companies who depend upon imports from China or the tourism industry. In this market decline, we’ve seen businesses lose value across the board. Companies like NBC Universal and Uber (who no longer operates in China) were also down, indicating the larger market may have been overpriced and in need of correction.
Should Retirees Cash Out?
Some have said, “I’m too old to go through another 2009,” and their anxiety is understandable. However, retirement is not the end-all for an investment portfolio. In fact, many can spend 25-30 years in retirement, which means your investment portfolio needs to be invested for that time frame also. Whether the market is down for a short-period due to the coronavirus, or a long time due to a market cycle, investors should not cash out their portfolios for an event that will likely be ineffectual to a long-term investment strategy. Likely, the market will recover before the end of the epidemic, causing those who cashed out to buy back at a price higher than they sold for.
Take another long-term asset like your house for example. Did you sell your house when the housing market was crashing in 2009 in hopes of staving off paper losses? Did you plan to buy your house back just as the market began to recover to make a bigger profit on your investment? No! You plan to live in your house the rest of your retirement, so whether the house is valued lower in 2009 is irrelevant if it provides you shelter the rest of your retirement years. The same can be said of a well invested portfolio. It may be down some years, but it will recover and be on the plus side as long as you don’t make knee-jerk reactions.
On the contrary, you should consider a distribution when you have a set expense approaching in the next one to two year window. For example, if you are looking to buy a house, start that overdue bathroom remodel, or put a child in college this Fall, take the funds allocated for that expense out of the market so that you aren’t forced to pay a bill right when the market is down, locking in losses.
How do I prepare for the market ahead?
Market timers tout that they can sell now, before the bottom hits and get back in, just as the market starts to turn around. In theory, that sounds like a great strategy, but is rarely instituted effectively in practice. To time the market, you have to be right two times: You have to know when to get out of the market and when to get back in. Statistics have shown market timing produces lower average annual returns than a diversified portfolio.
Diversification is one of the most effective strategies for dealing with volatility. Inversely correlated asset classes are paired together so that if one sector of the market is down, another sector of the portfolio is up, offsetting losses. It is one of the most effective ways to reduce losses during a market downturn so you can recover quicker when the market improves.
Rationally speaking, you have two choices:
1.) Ride out the market downturn (short or long) and experience the next rise. You will be relieved that the markets were not down permanently for the first time in the history of the stock market!
2.) If the market volatility gives you angst and you cannot sleep at night, meet with your Certified Financial Planner™ to determine if you need a permanent reduction in your portfolios risk exposure. Making a prudent change could save you from making a panicked decision with long-term financial damage.