The outbreak of COVID-19 has led to a global health pandemic that is having an enormous impact across the world, and our hearts go out to everyone who has been impacted.
At DHGWA, our passion is to enrich our clients' lives by providing financial clarity and peace of mind. While it’s impossible to know what the outcomes of this global health crisis will be, and how long it will last, we are committed to providing insights on global market activity, and what that means for you. We take our responsibility as your advisor very seriously and are here to help you navigate through this storm.
On February 19th, 2020 financial news headlines celebrated a new all-time high of the S&P 500 index. The next day began a sell-off that has seen the index decline by 19.04% (as of close on March 11th, 2020) in just under 3 weeks. Yesterday, the Dow Jones Industrial Average officially entered into a Bear Market (defined as being down 20% or more off the last market high) and early morning indicators today point to the same for the S&P 500.
Volatility during this period has been primarily driven by concerns about the economic impact of COVID-19, but the recent showdown over oil prices between Russia and Saudi Arabia and uncertainty around the upcoming U.S. presidential election have contributed as well. Markets have reacted swiftly and adjusted prices back towards levels last seen in the summer of 2019.
U.S. Equity Returns Following Sharp Downturns
While sudden market downturns can be unsettling for investors, staying disciplined and focused on your long-term goals helps put you in the best position to capture a recovery as illustrated in Exhibit 1.
Exhibit 1: Fama/French Total US Market Research Index Returns (July 1926-December 2019)
Source: Dimensional Fund Advisors. 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.
As you can see, a broad market index tracking data since 1926 in the US shows that stocks have generally delivered strong returns over one-, three-, and five-year periods following steep declines. In fact, every time period except one shows annualized returns that are higher than the long-term average.
Exhibit 2: Annual Returns and Intra-Year Declines
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. Intra-year drops refers to the largest market drops from a peak to a trough during the year. For illustrative purposes only. Returns shown are calendar year returns from 1980 to 2019, over which time period the average annual return was 8.9%. Guide to the Markets – U.S. Data are as of March 10, 2020.
Exhibit 2 shows calendar year returns for the US stock market since 1980, as well as the largest intra-year declines that occurred during a given year. During this period, the average intra-year decline was about 14%. About half of the years observed had declines of more than 10%, and around a third had declines of more than 15%. Despite substantial intra-year drops, calendar year returns were positive in 30 years out of the 40 examined. This goes to show just how common market declines are and how difficult it is to say whether a large intra-year decline, such as the one we are currently experiencing, will result in negative returns over the entire year.
As the global science, healthcare and business communities come together with local and federal government agencies to tackle COVID-19, we can expect to see a triage of health policy, fiscal policy, and monetary policy designed to solidify both public health and the world economy. The effectiveness of these policies will be tested and measured by markets daily, and it is critical to remember that while markets are measured daily, stocks and other financial instruments are owned for their long-term growth potential. One of the reasons why stocks have shown resiliency over the long term is that successful entities demonstrate resiliency and innovation in the face of crisis, disruption and change.
For clients of DHGWA, we want to remind you that your chosen investment allocation reflects your goals, your risk tolerance, and your time horizon, and that your portfolio was built considering both the upside growth potential and the downside risk associated with that allocation. While market volatility can be nerve-racking, reacting emotionally and changing long-term investment strategies in response to short-term declines can be more harmful than helpful. Our advice to you is clear: now is the time to stay focused on your long-term goals, and to continue to adhere to your well thought-out, risk-appropriate investment plan in order to be in the best position to capture the long-term benefits of investing in the stock market. We are here to advise you. If you have questions about how the recent market volatility impacts you and your plan, please give us a call.
The content in this article is for informational purposes only and does not constitute investment advice or an offer to buy or sell any security. The information in this newsletter is believed to be accurate as of the time it is distributed and may become inaccurate or outdated with the passage of time. You should contact your financial advisor or CPA professional before making any tax or investment-related decision. Past performance does not guarantee future results. All investments may lose money.