Staying Invested During Times of Volatility
March 16, 2020
From the peak of the market through the market’s close on Friday March 13th, the S&P 500 has fallen nearly 20%. This week it has continued to decline further. “Social Distancing,” encouraged by health authorities to prevent the spread of the COVID-19, is causing a slowdown in the global economy. The depth of the slowdown is as yet unknown, but many prominent economists now believe that COVID-19 will precipitate a worldwide recession. The stock market seems to be predicting this through its current pricing. While these are uncertain times, it is clear that we are in for at least a “transitory shock” as the IMF’s chief economist recently stated, and maybe worse.
What’s important to remember is that the immediate health hazard is likely limited in duration. The world’s scientists remain optimistic that we will discover a vaccine for this disease, as it is in a relatively familiar class of virus for which we already have vaccines and treatments in place. When progress is announced on a vaccine and/or treatment, the market will undoubtedly surge as optimism returns.
There are two important investment principles that guide our thinking during these times. The first is that markets traditionally recover after large drops, and the rebound tends to be rapid, as shown in the chart below:
Annualized Returns Following Market Declines
Source: Dimensional Fund Advisors, Fama/French Total US Market Research Index Returns. July 1926-December 2019
The second principle is the importance of staying invested during the rebound. Reacting by selling out can have a dramatically negative impact on performance. The chart below shows the how missing out on just a single day of performance can have a negative impact on long-term returns. Consistently missing out on the best days of performance can have an even greater impact.
Reacting Can Hurt Performance:
Source: Dimensional Fund Advisors; See footnotes
The key to weathering this storm is staying invested and maintaining faith in the future of the world economy. We will discover a vaccine to stem the tide of this disease, or it will pass first like so many epidemics before it. We don’t know how much further the markets will fall or how deep the recession might be, but we want you to participate in the rebound when it happens. For our clients who are invested for the long run, we feel confident that we will look back at this shock to the system as having been another one of the several temporary – albeit dramatic – downturns we’ve seen in our lifetimes.
Footnotes:
“Reacting Can Hurt Performance Chart”: In US dollars. For illustrative purposes. The missed best day(s) examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best day(s), held cash for the missed best day(s), and reinvested the entire portfolio in the S&P 500 at the end of the missed best day(s). Annualized returns for the missed best day(s) were calculated by substituting actual returns for the missed best day(s) with zero.
S&P data © 2019 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. “One-Month US T- Bills” is the IA SBBI US 30 Day TBill TR USD, provided by Ibbotson Associates via Morningstar Direct. Data is calculated off rounded daily index values. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.