As the chart below demonstrates, the stock market over the long term is an amazing wealth-generating machine. But the cost of reaping its benefits over the long term is staying the course through a agonizing times of worry and panic, the vast majority of which will not end up having a lasting impact. Currently the market has entered into “correction” territory, meaning a decline in the major indexes or more than 10%, as a result of the global outbreak of the coronavirus.
Is this the normal occasional pull-back or something bigger? In today’s world of 24-hour cable news hype and scary click-bait headlines, it can be difficult to find perspective. There is a lot we still don’t know. There are also a number of historical precedents that help shed light on how to behave in down markets and how the markets have reacted to epidemic scares in the past.
The first point to remember is that corrections are business as usual and are the cost of admission for owning stocks. During the rally since 2009 there were corrections in 2010, two in 2011, 2012, 2015, 2016 and two in 2018. And yet the market kept rising. Still the S&P 500 is up 18.5% since the beginning of 2019. This far exceeds the long term average annual return that we generally expect from stocks.
There is an overwhelming body of evidence that suggests that timing the market does not work in corrections. To try to do this would be to incur a tax impact while trying to time both your exit and re-entry to the market and would be far riskier that simply staying the course.
Secondly, it is useful to look at past epidemics and how the market responded. This chart below tracked epidemics going back to 1980.
Over this period the 6-month change of the S&P 500 Index following the start of the epidemic was positive in 11 of the 12 cases, with an average price return of 8.8%. The 12-month change following the start of the epidemic was positive in 9 of the 11 cases, with an average price return of 13.6%.
As information continues to come out about the particular nature of the coronavirus and how it compares to previous epidemics, it is helpful to stay focused on the facts and the real impact on corporate earnings, which are the true long-term driver of stock market returns, rather than sentiment or media hype.
This is an uncertain time and a real human tragedy for many people, however, we believe strongly that this is the most important time for investors to maintain their commitment to their long term financial plan. A growing body of research has identified that “behavioral alpha,” the finance term for the extra returns generated from avoiding costly emotional mistakes, as one of the main drivers of long-term investment success. This is the time when sticking to your plan really counts.
Presented by the Investment Committee of Lake Street, an SEC Registered Investment Adviser.
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.