Note: This post was written for J. J.'s Facebook author page, not necessarily for the audience of this book and site.
Today is Saturday, March 14, 2020. There’s a lot going on in the world right now, but I’ll stay in my lane and talk about what I know: investing in capital markets, i.e. the stock and bond markets.
We just witnessed the first week since 1929 in which the S&P 500 was either up or down more than 4% every day from close to close.
The Dow Jones Industrial Average was down 9.9% from the close on Wednesday 3/11/2020 to the close on Thursday, March 12, 2020. It represented the 7th worst day ever for the Dow Jones Industrial Average (DJIA), and the worst day since Black Monday in 1987, when the DJIA was down 22.6% in one day.
The market followed that up with a massive rebound on Friday 3/13/2020. The DJIA was up 9.3%, good for the 12th best day ever.
(Thank you to Ryan Detrick of LPL Financial for the stats).
Risk happens fast. There is an old adage, stocks take the stairs up, and the elevator down. If you’ve been following along at home, you have seen this adage come true yet again.
What’s an investor to do? I’ll touch on my assessment of the current coronavirus situation at the end of the post. Before we do, let’s discuss “risk”.
First off, let me get my disclaimers out. I’m not here to give advice, I’m here to help you educate yourself. If you want advice, get a financial advisor. Regardless, you should educate yourself so you can make good decisions with or without an advisor.
Second disclaimer, I’m not one to try to predict the future. I don’t believe that’s a skill any of us possess. That being said, I do analyze data and price movements, as well as historical precedents, to develop a hypothesis and try to improve the probabilities of success. I also try to balance my risk by diversifying into asset classes that don’t all move on the same waves. (All of this is a discussion for another day. This post is long enough already.)
With that out of the way, let’s talk about risk.
Risk happens fast, as Mr. Market has reminded us. Money in the market is money at risk. Money in individual stocks is even more at risk.
Often times, the risk of loss may be temporary. Other times, it may be permanent.
It is imperative that an investor have a proper plan going into buying stocks. Are you prepared for things to go poorly? It is just as important to have a plan for when things go well. If you’ve been riding the bull for several years to healthy gains, you also need a plan for how to protect those gains. A month ago was a better time to think about that (obviously with hindsight).
“To know thyself is the beginning of wisdom” Socrates
It is very important that you don't take on more risk than you can live through. Don't EVER invest so much into any one stock or even the stock market, that a loss would be catastrophic. If the risk of losing money keeps you from enjoying your daily life, you are taking on too much risk. Know what you can tolerate. If you can’t take on the risk, then don’t.
Risk is the price of admission when you are seeking rates of return higher than owning cash. For that reason, it is important to manage your risk (on multiple levels).
The first step to managing your risk is developing a good financial plan that incorporates risk management techniques. I go deeper into the components of a comprehensive financial plan in this blog post, Financial Planning: The Thing You Do Before You Buy Stocks.
One of the first things a good financial planner will tell you, is that you have no business buying stocks if you don’t have an emergency cash reserve in the bank or a money market fund. Your first financial goal needs to be a rainy-day fund for the inevitable storm. If an unexpected expense meant you would be forced to sell your stocks, you shouldn’t have stocks.
Rule #1: Short Term Assets (Cash Accounts and CD's) for Short Term Goals like your Emergency Fund / Long Term Assets (Bonds and Stocks) for Long Term Goals like Financial Independence.
Stock prices move up and down quickly and are meant to be owned for long-term holding periods. You cannot hold them for long periods if you are buying them before establishing an emergency reserve. If you are going to need to use the money in the near future, don’t own long-term investments.
Stock market investments need time, at least 5 years but preferably more. There are no guarantees that 5 years is enough. You may lose money.
You own a piece of a business when you own a share of stock. If you own your own business, you know you need to take a long view of its success. Stocks are no different.
For perspective, below are the stats for the percentage of returns in the S&P 500 that were positive or negative based on how long it was measured. For example, 56% of the time the market moves up from one day to the next. 44% of the time it moves down (and yes there are some rounding errors in the data below). Notice the percentages change substantially over longer time periods.
A few more charts, because I LOVE charts. They can paint quite a picture. If by some miracle you are still reading, maybe you like charts too. Anyway... The next chart shows calendar year returns (Jan 1 - Dec 31) for the S&P 500. Notice that there are bad years - some are VERY bad.
The next chart shows calendar year returns each year, but also shows the difference between the high and low of that year. Put another way, what was the return if you hypothetically bought the top and sold at the bottom that year. Notice the average drop each year is 13.8% historically. This year, we already have had a 20% drop from the highs, and it has been the fastest such drop in history.
One more table to show you what happens when things go wrong. The table below courtesy of The Leuthhold Group shows the performance of several asset classes since their peak. Notice the Energy sector is down around 70% since June 2014. That means $10,000 invested in the energy index in June 2014 is worth around $3,000 today. A 200% return from here would get you only to $9,000, 10% below the highs.
I give you these stats, not to scare you, but to help you understand the importance of having a good plan that takes risk management into account.
The 11-year bull market has contributed to a sense of complacency among investors. The last month may have shaken that complacency out of many, but time will tell.
That brings us to today, and the current situation with the coronavirus. Obviously, we are in a very fluid situation in the U.S. and around the world.
It doesn’t take much foresight to see a recession in economic activity occurring in the US and around the world as we socially distance ourselves to slow the spread of the virus.
Stocks are businesses. Stock prices follow the anticipated path of company earnings.
Unless you are in one of the small handful of businesses that benefit from a run on consumer staples and healthcare products and services (think Costco), chances are, business is hurting.
Is the recession priced in yet with the drop?
For some investments, perhaps yes. For others, probably not. We really don’t know, as the situation is so fluid.
Investment selection matters!
Keep in mind, not every business is having the same experience. Some businesses have seen little or no change. Do you really think anyone is cancelling their cell phone or internet service over this?
Many people have pointed to previous viruses that have stricken the globe (H1-N1, SARS, etc.) as an example that the world is overreacting. We certainly saw more deaths and illnesses in previous episodes compared to the current situation. Hopefully, thanks to the efforts being made, we don’t see a repeat of the numbers from H1-N1 and others. Regardless, I’ll leave that judgement to others – I focus on what’s happening to the economy and to companies.
The fact is, those previous instances of outbreaks DID slow the economies of Asia that were most impacted. It DID impact company earnings, just not as much in the U.S.
This crisis is different from an economic standpoint, especially in the West.
What we didn’t see then, and frankly have not ever seen in my short life (I’m 42), is the type of social distancing in place now. We didn’t see travel restrictions like we do now across the globe, and in the U.S. This is quite unprecedented in recent history. We have turned off large parts of the global economy, and there are ramifications for that.
It can be anticipated that economic data will become exceptionally soft for the next few months. Companies and analysts will begin to issue new earnings guidance over the coming weeks and months. Companies are already reacting by drawing down credit lines, anticipating tighter bank lending and credit markets. Jobs will be lost, and lives will be impacted in a material way.
I compare the current economic environment to the economic environment following the 9/11 attacks. You may recall, we saw travel screech to a halt at the end of 2001. The stock market suffered as well but remember that much of it had been suffering for almost two years already when 9/11 occurred. The bursting of the tech bubble in 2000 was still a fresh wound. Fear was in the air then as now.
(Also remember that we united as a country post 9/11 in a way I had not seen before, and certainly not since. Can that happen again?)
Fortunately, with the current crisis, we come into the situation from a much stronger position economically than in the previous two recessions from the 2000’s. The 2002 recession was a “double dip” following what occurred in 2000-2001. The 2008-09 crisis was also a real estate crisis made worse by the fact that we sold our (prime and sub-prime) mortgages to the rest of the world in the form of securities.
In 2020, we are on the heels of an 11-year bull market in stocks, reflective of the incredible recovery since 2009.
Unemployment is very low. It will likely go up, but we are starting lower than in previous crises.
Personal debt is much lower than in 2008 thanks to an abnormally high savings rate by Americans since then.
There’s still a TON of debt out there, but it is more of the “corporate” variety. Companies have taken advantage of low rates to borrow. No doubt, there will be pain to go through for companies with a business that is “on the edge”, but by and large, corporations are prepared for a recession. Just like consumers in 2008-09, many corporations learned lessons from the financial crisis. Not all, but many.
Rates are VERY VERY low today. They were MUCH higher in 2002 and also in 2008. This softens the blow.
Markets are more liquid than in 2008. This might be too inside baseball, but the Fed is better prepared to provide liquidity to financial markets. I tend to be highly critical of the Fed but was happy to see the emergency rate cut this month and I expect another cut this week or next.
I’m not a proponent of “intervention” and “bailouts”, but I am a proponent of providing a means for banks and companies to acquire cash to keep business flowing. In 2008, we wondered if the Fed was making it up as they went along. We’ve learned over the last decade that, yes, they WERE making it up as they went along. Today, they are running more of a playbook than just winging it, in my opinion.
As stated previously, the global economy comes into this situation from a relatively stronger position than previous crises.
None of us know how this crisis will unfold. We know the next two weeks are critical and will give clarity into the direction of things. We can expect rapid growth in new cases in the U.S. (and elsewhere) as we FINALLY see the beginning of testing, albeit unforgivingly slowly. Social distancing took a long time to come about, so it will get worse before it gets better. I pray that our healthcare system can handle the load better than Italy. I pray that we look back and say “well, that could have been worse”.
I cannot overstate the hero status of our healthcare workers. These men and women put everything on the line for their patients. Thank you for your service. Our hearts go out to those impacted.
As we hear the numbers come in, please keep in mind the following from Greg Valliere, my #1 source for information on Washington DC goings on.
“A Glimmer of hope amid the gloom comes from China, of all places. There were only eight new cases of the coronavirus in Hubei province yesterday (3/11/2020), according to Reuters. “The peak of the epidemic has passed for China,” a government official stated. Travel restrictions have been eased and businesses are re-opening. China’s data have been suspect but reports of lie returning to normal in the city of Wuhan are encouraging, and at some point, maybe in a couple of weeks, reports of new infections in Italy will level off. And at some time in April, a consensus may grow that the worst is over”.
Much depends on the capacity of the healthcare system. I pray the social distancing prevents the hospitals from being overrun as they were in Italy.
Given all of that, what do you do with your stocks? If you have cash should you buy?
One more time, I will remind you to consult your financial advisor, but let me offer my perspective.
If the 9/11 recession in 2002 and the financial crisis of 2008 – 09 are guides, we will eventually recover.
Is the bottom in? Maybe, but I expect the market to at least test the lows again to make sure. I won’t be surprised if we take out new lows as testin