The Roller coaster ride continues Week 2
Prior to the middle of February of this year, markets were on a real tear, climbing to record 15-year highs. However, equities dramatically declined last week amid a large spike in volatility as fears that the coronavirus would turn into a global pandemic rattled all markets. Many investors rushed to safe-haven global government bonds as long-term yields fell to new lows. Some rushed back as the market went down, up and then down again last week. But today a decline in oil prices resulting from the Coronavirus was dramatically escalated by a price fight between Russia, Saudi Arabia and OPEC. Oil dropped 30% or so which is the worst drop since the Gulf War. That's an stunning move which will be felt by many in different industries for a while. In turn, equity markets fell further and more dramatically everywhere and so now we are basically back to a where we were a year or more ago. Bond yields are lower but fixed income remains the hedge we expect in equity downturns (despite the fact that clients regularly wonder why they need it). And so it goes...
This roller coaster ride that has created much anxiety for many investors (and advisors) leads naturally to the question "What do I do now", which is not a fun place to be. While market corrections can be really hard to endure, they’re not an uncommon occurrence. There have been 37 corrections in the market of more than 10% since 1950. Thirty Seven! When markets are up everyone is happy. When markets go down, fear and panic can set it pretty quickly and dramatically (accentuated in the past few years by technology working overtime). Indeed, research has shown that losses make us feel much worse than gains make us feel good by a factor of about 3 to 1. So, while I can't predict how big and how long this roller coaster ride will last here are some things I do know:
Markets go up and Markets go down. Over time. Always.
- Economies are cyclical, and they expand and contract which is why the market is not always stable. But sometimes instability as we have witnessed recently, can be caused by an unpredictable outside event like COVD-19 which acts as a tipping point. The chart above from Mackenzie and Bloomberg shows the bull and bear markets in the S&P/TSX Composite total return since 1956. All bars above the line are bull markets and all bars below are bear markets.
- We're down from a BIG high. The market has been on a (net) upward trend for a long while. It's been the longest bull market ever and it's been nice that's for sure. Just a few months ago we were celebrating the fact that the S&P500, Dow Jones and Nasdaq had closed 2019 with gains of between 22-35%. All is not lost. Major equity markets have given back much of their 2019 gains but will come back again we're just not sure when.
- Emotion moves markets. Most corrections are driven by a lot of emotion. This one is no different despite the fact that people will say that this time is different because there's fear about a pandemic. However, each time there has been a decline it is because of something different. The constant is the emotion side -Fear versus Greed. It's important to remember that there have been 18 times that the market has fallen 5% off it’s high since the market started climbing back since 2009.
- Your portfolio is not the index. When the media talks about the market being off 5%-10% they are talking market weighted indexes like the S&P/TSX Composite, the S&P 500 or MSCI all-country global index. But your portfolio would only have declined by that amount if you’re all in on equities. If you’re all in on equities-you should talk to a financial planner
- Predicting the future is hard. No one can predict with 100% accuracy especially over the short term. Over the short term, stock markets go up and down. Over the medium term, stock markets generally go up. Over the longer-term stock markets have gone up.
- Know your risk tolerance/Have the right asset mix Your risk tolerance is personal. Higher returns come with higher risk but if you're worried about a 5% correction you probably should be in cash or GICs. If you want more stability and less volatility, then you should have less equities in your portfolio in favour of fixed income and should expect lower returns. If you are close to retirement or if you plan on spending the money in your portfolio within the next couple of years, you should not take on a lot of risk and should be reducing your equity exposure accordingly. You need to sleep at night. Act accordingly and talk to your advisor/financial planner.
- Be like Warren Buffet The most successful investors are well diversified, optimistic and patient and they know their tolerance for risk and will balance their portfolios accordingly. It’s important to review, rebalance and reposition between asset classes at least 1-2 times per year especially when equity markets are performing well because the equity portion of your portfolio will grow faster. Life is busy but your financial planner should be reaching out to you to make sure you are rebalancing. That’s the job they are paid to do except of course if you’re dealing with a robot that does not provide financial planning services
- Time in the market not timing is key. The longer you are in the market, the better your chance of success. So, when a market correction occurs, it's important not to panic unless you are a very short-term investor. Discipline during a market correction is key.
- There is no such thing as a perfect portfolio. However, diversification and asset allocation are critical to ensuring that not everything in your portfolio goes down at the same time. Equities are down right now but the loss in your portfolio is being mitigated by the fixed income or alternative investments in your portfolio. Those lesser yields offered by fixed income are hard to appreciate except when those assets buffer you from greater declines. Diversification across sectors and countries also matters. As an example, this period of volatility is particularly hard for public companies like airlines, hotels, travel operators, mining, energy and luxury goods retailers That’s why you need to be diversified at all times across multiple industries/sectors and across different countries.
- Uncertainty leads to panic and speculation. The truth is that no one really knows what kind of an investor they really are until stocks are falling. There is every reason to believe business activity will return to normal after the virus runs its course as long as the fundamentals are in place and consumer confidence is positive. In the meantime, we can probably expect the steady flow of coronavirus-related uncertainty to persist and cause more volatility (and anxiety) in the near term. Uncertainty in the market right now is leading to all sorts of speculation. The big uncertainty is about how long this virus will last as well and how severe it will get and what the financial impact on companies that trade in the market will be. No one has the answers. The market impact of SARS was largely limited to one or two quarters but it’s hard to compare since a lot has changed in global markets since 2003. More than 60% of market corrections in the past lasted 104 or fewer days.
- Bull markets are on average longer and provide a more significant percentage change. As the chart above (and below) shows, a bull (bear) market is generally defined as a positive (negative) move greater than 15%. that lasts at least 3 months. On average, bear markets are briefer but engender fear despite the fact that this is when significant ‘bargains’ can be found
- Panic selling is not a good long term strategy. Patience is key for investment success. Nobody likes to see their investments decline but if you’re thinking about selling now your losses are permanent and eventually you will have to make the decision about when to get back in. (Go back to note 5) It’s hard to predict when the market will start climbing again but there is no disputing the fact that the decrease in prices does provide a good buying opportunity that wasn't there before the correction. Look for investment opportunities that show a history of strong earnings, a solid balance sheet and income not just growth
Put a Plan on Paper!
The market is indeed, hard to predict-up or down. No one knows until they know. Generally, if you're a long-term investor with a tolerance for short-term volatility there should be reduced need to sell equities in a panic. The bumps along the way will not have a long-term impact and this correction may provide good opportunities to rebalance and buy on sale. There is a potential for short term losses during these brief periods of corrections, but the market generally leans toward stability and average returns over time. That's why it's also important to have a comprehensive and personal financial plan in place that is realistic and not built based on high expectations. Realistic and responsible financial plans should be based on conservative assumptions about returns of 4-6% but can vary based on a client's risk tolerance. Generally happy surprises are always way better than unhappy surprises.
Financial advisors must often act as psychologists during downturns which is funny because I have a psych degree. Please feel free to connect with me for a "session" should you need to chat. Always.