During the past week and a half headlines have screamed with the news of the equity markets significant declines in large part due to concerns related to the coronavirus. Less attention-grabbing, but equally important is the dramatic increases in fixed income products driving some into record territory (On Tuesday the 10 Year Treasury Yield dropped below 1.00% for the first time ever). Our long-term investment philosophy does not recommend trading in light of short-term market movements, no matter how severe, and as a result we have not received many calls or emails from concerned clients. Nonetheless, even the most harden investor surely must have been shaken a bit by the events in the past few days.
When markets change this quickly, as they are prone to do, it can come as a shock and raise questions about whether they might fall further or whether changes in a long-term allocation plan are appropriate. While we continue to think that making changes to a long-term allocation plan in response to short-term volatility is almost never warranted, we still wanted to provide some perspective on risk and the events that are driving the market.
1. Stock and bond markets are forward-looking, and the stock market has already incorporated the possibility that the coronavirus outbreak could spread further. From here, how the stock market moves will depend upon whether the outbreak is better or worse than currently expected. To place a trade now based on your fear or lack of fear relating to the coronavirus assumes you know more about the future than the market as a whole. Because it’s not possible to consistently outguess the market’s best estimate, we recommend most of our clients should stick with their existing strategy.
2. While the stock market has been relatively calm over the last decade, there are typically multiple points in the year where it declines, even during years where returns are positive. Data compiled from the Fama-French Library shows that the U.S. market has had 158 different two-day periods where it declined by 4% or more, 49 where it declined by 6% or more, 15 where it declined by 8% or more, and five where it declined by 10% or more. Because there are about 90 years of high-quality history for the U.S. market, this means that, for example, declines of 6% or more over a two-day stretch tend to occur about once every two years. In other words, markets have a notorious history of sharp declines even though they tend to go up over time. In the moment these events can feel extreme, but they tend to occur more frequently than most investors would guess.
3. Markets have experienced multiple other periods with outbreak-related scares. Dow Jones compiled data associated with 12 other outbreaks, and the following table reports those events along with the returns of the U.S. market in the six and 12 months following the outbreak month.
While the market responded negatively to some of the above events, the U.S. market tended to be up significantly in the six and 12 months following. No one can predict exactly how the coronavirus will proceed, but markets are typically very efficient at pricing risk.
What should a long-term investor do about short-term market volatility? We believe inaction is going to be your best course of action. Your comprehensive financial plan is fully cognizant that volatility will occur – whatever the underlying event may be – and incorporates such outcomes.
Important disclosure: Indices are not available for direct investment. The above performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results.