Egg aisle at my HEB yesterday
About a month ago, I attempted to answer “Should You Worry About Coronavirus?”
In the article, I suggested that things will likely get worse before they get better, if past similar scares were any guide. Looks like that was a good guess.
Now a month later, the shelves are empty, the Robert Earl Keen show I was planning to see is cancelled, and the world has seemingly come to a halt as coronavirus has spread. The uncertainty being felt around the globe is concerning on a personal level as well as from the perspective of how markets react. Now what?
Markets are designed to handle uncertainty, allowing buyers and sellers to process information in real-time as it becomes available. We see this when markets fall sharply, as they have this week, as well as when they rise. Selloffs can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.
One major reason that markets decline is when investors reassess expectations for the future. If people aren’t leaving their homes, a lot less stuff is going to be purchased in the next couple of months. That means the earnings of the companies that make things that people normally spend money on are now likely going to be lower, although you could also surmise that those earnings will quickly rebound when normalcy returns. With lower expected earnings come lower stock prices, all other things being equal. As the outbreak expands, worry among governments, companies, and individuals about the impact on the global economy has also grown.
The market has responded to new information as it becomes known, but the uncertainty of how much worse it may get is also being priced in. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. ATX Portfolio Advisors’ investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.
US Equity Returns Following Sharp Downturns
Past performance is no guarantee of future results. Periods in which cumulative return from peak is -10%, -15%, or -20% or lower and where a recovery of 10%, 15%, or 20% from trough has not yet occurred are considered downturns. For the 10% threshold, there are 3,442 observations for 1-year look-ahead, 3,396 observations for 3-year look-ahead, and 3,345 observations for 5-year look-ahead. For the 15% threshold, there are 3,175 observations for 1-year look-ahead, 3,167 observations for 3-year look-ahead, and 3,166 observations for 5-year look-ahead. For the 20% threshold, there are 2,561 observations for 1-year look-ahead, 2,560 observations for 3-year look-ahead, and 2,560 observations for 5-year look-ahead. 1-year, 3-year, and 5-year periods are overlapping periods. The bar chart shows the average returns for the 1-, 3-, and 5-year period following market declines. Data provided by Fama/French, available at mba.tuck.dartmouth. edu/pages/faculty/ken.french/data_library.html. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP. Short-term performance results should be considered in connection with longer-term performance results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
I can’t tell you when things will turn or by how much, but I expect that taking risk today will be compensated with positive expected returns. That’s been a lesson of past crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as The Great Recession of 2008–2009. Because I know of no reliable way to identify a market peak or bottom, I advise against making market moves based on fear or speculation, even as awful trading days unfold like they have this week.
What I can help with is developing a long-term plan that should let you stay the course in a variety of conditions. We consider a wide range of possible outcomes, both good and bad, when helping you establish an asset allocation and plan. Those plans include the possibility, even the inevitability, of an occasional downturn. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.
We have used those plans in the past few days to make rebalancing trades in clients’ accounts and to allocate cash for those brave souls that have decided to invest some “dry powder”. I don’t know if the market has bottomed, but I can say confidently that expected returns are higher today than they were a few days ago. Oh, did I mention that I don’t charge my Accountable Wealth Management clients any fees during months that their account balance falls? We are all in this together.
If you need to create or review your plan, now may be a great time to get in touch.