It often feels like the stock market takes the stairs up but the elevator down. The latter rings true currently, with stocks falling more than 20% from the peak, crossing the official threshold of a bear market for the first time in more than a decade. And they did so in record time: U.S. stocks sat at record highs less than one month ago.
As unsettling as this selloff may feel, don’t lose sight of that staircase. Even with this decline, the stock market is:
- Back where it was in early 2019
- Still 5% higher than during the pullback in December 2018
- Up 20% (including dividends) over the past five years (an average annual gain of 4%) and 345% over the past 11 years (a 12% annual gain)1
The velocity of this selloff and the magnitude of the daily swings are a reflection of the unique risk of this human health crisis and the unprecedented efforts to contain the virus’ spread, which raise the uncertainty around the ultimate timeline and impact. Market selloffs are fed by fear and are eventually exhausted when extreme pessimism is priced in and investments become re-anchored to the broader outlook for fundamentals.
We think investors can take comfort that:
1. There appears to be a high degree of pessimism already in the market at these levels
2. The health of the economy entering this unique situation will play a key role in fostering its rebound as the virus runs its course
3. Diversified portfolios aren’t mirroring the stock market decline
1. Avoid the temptation to panic.
This pullback, just like those before it, won’t last forever. You’ll want to be invested when the rebound takes shape.
2. Measure your progress against your goals, not the peak value of your portfolio or short-term fluctuations.
If your goals haven’t changed, your strategy to achieve them shouldn’t either.
3. Put time on your side.
You’re investing for the long term, so use that to your advantage.
4. Leverage the power of diversification.
A balanced portfolio of 65% stocks and 35% bonds has held up better, dipping roughly half as much as the Dow.*
5. Lean in to volatility.
History shows the best times to be opportunistic are when it feels toughest to do so.
Volatility is unlikely to end soon. We think the bottoming process may require the following:
A peak in the rate of new confirmed cases of coronavirus in the U.S. –
The pace of new cases will need to slow before a sustained rebound can occur. Experiences in China and South Korea suggest an inflection point when new cases peaked.
An effective and sizable fiscal policy response –
Washington is evaluating tax cuts, support for impacted workers and business loans/funding. This won’t fully solve the challenges, however, full-scale fiscal stimulus will likely be needed to bridge the gap for the economy and market confidence.
Further monetary policy stimulus, with the Federal Reserve cutting rates near zero –
Rate cuts won’t solve a human health crisis. However, the Fed will likely cut rates near post-financial crisis levels to add at least a pillar of support to financial markets. If this happens, we’ll emerge from the brunt of the virus slowdown with incredibly stimulative monetary policy settings, which we think will help supercharge the economic and market rebound.
Downward corporate earnings revisions –
It’s unclear just how punitive this will be on corporate earnings in the next quarter or two, but we think earnings estimates for 2020 will need to come down dramatically. This will be another metric that will help markets stabilize and look ahead to the future rebound in profits, which are the long-term guide for stock prices.
The range of unknowns raises the uncertainty around the timing of a rebound. While we don’t attempt to time the market precisely, as a long-term investor, you should take comfort in the advantage of time in the market, not timing the market.
However, we remain confident that a rebound will take shape. It may take a while longer to materialize, but we think it will be robust and fueled by a return of confidence in the post-virus outlook. Long-term investors don’t need to capitalize on the pullback all at once but should consider opportunities to benefit from this decline. Consider:
Rebalancing – Trimming overweight allocations and filling gaps in underrepresented asset classes and sectors
Systematic investing – Taking advantage of the ongoing volatility by systematically investing at regular intervals, reducing the “timing” aspect as the selloff plays out
Within a matter of weeks, markets have dropped to a level that to us is pricing in a U.S. recession, an economic outcome that looks increasingly likely, in our view. In a consumer- and service-oriented economy, widespread containment efforts make a contraction in GDP a selffulfilling process:
- Historically, the stock market peaks on average roughly six months before a recession emerges, with economic conditions decelerating before eventually falling into contraction. Current conditions are anything but typical, given the unprecedented measures being taken to limit contagion. The flipside to this story, from an economic and market perspective, is more encouraging, however.
- The market has declined by roughly 25% from the recent highs, nearly in line with the average bear market decline. It’s uncertain at this stage if this experience will be similar to past bear markets, but this suggests a substantially negative economic and earnings outcome is being priced in to stocks already.
- Given the root of the slowdown, we think the downturn will be temporary. This is not, in our view, a repeat of 2008/2009. The financial and banking system is on firm footing, and we don’t anticipate unemployment to experience a sustained spike, as is the case in traditional recessions and a root cause for a more slowly developing recovery. Given the economic foundation, we think a recovery in economic activity and investment can be faster and more vigorous than normal.
Looking back at bear markets (a decline of 20% or more) since 1955:
- The average total decline was 26%.
- The time from the initial 20% drop to the bottom of the market averaged 86 days.
- The stock market returned an average of 25% over the next year and 32% over the following three years.
The following table looks specifically at downturns driven more by events that shocked the market rather than a traditional end to the business cycle.
Source: Bloomberg, Edward Jones. S&P 500 Index total return.