Stocks rebounded on Monday as investors overcame fears of the spread of COVID-19, the novel coronavirus, and its impact on global economies.
The major benchmarks plummeted last week and reached losses that were the worst since the Great Depression in 2008.
Investors who set aside their emotions were able to cope with the massive pullback in the market. Staying in the market reaps greater rewards over a longer period whether you are saving for retirement in a 401(k) plan or IRA account or are an active investor.
Instead of being fearful that volatility occurs, investors should expect it to happen, said Shawn Cruz, a manager of trader strategy at Omaha, Nebraska-based TD Ameritrade.
“The biggest key is not to panic not after the market flushes 8%,” he said. “You leave a lot on the table.”
The biggest challenge for investors is controlling their emotions, said Michael Underhill, chief investment officer of Capital Innovations in Pewaukee, Wisconsin.
Over a 30-year period, the average investor generates a return of 2% because they sell when prices are low and buy when prices are high, he said.
Even the experts can not accurately forecast the outcome of COVID-19. Focusing on the earnings of companies with healthy profits and balances sheets is a better strategy.
“The earnings of these companies will recover because this is a transitory event,” Underhill said.
Following the herd can yield in many pitfalls.
“Human psychology is wired to buy when everyone else is buying and that is the worst time to buy,” said Daren Blonski, managing principal of Sonoma Wealth Advisors in Sonoma, California. “The best time to buy good quality stocks is when everyone is selling.”
Investors who did not sell their holdings during the financial crisis in 2008 have generated large returns since that decline in market value.
“I keep cash on the sideline for times like this,” he said.
Comebacks After Large Losses Are Often Record-Breaking
The rebounds in the stock market after large declines are often “record breaking,” says Jodie Gunzberg, chief investment strategist of Graystone Consulting, a Morgan Stanley business.
The instances of positive returns outweigh the chances of negative returns. While the S&P 500 lost 0.82% on Feb. 28, this loss is not unusual. Daily losses of this size have happened in 14.8% of days since January 3, 1928 for the past 23,149 days, she said.
Feb. 28, 2020 was the seventh consecutively negative day, which has happened 106 times or in 0.46% of periods, Gunzberg said.
The loss of 12.76% over the seven-day period was the 80th worst seven-day loss, which has happened in 0.35% instances. The last seven-day loss of this size occurred Aug. 10, 2011, losing 12.91%.
While the five-day week ending Feb. 28 closed down 11.49%, posting its 11th worst week on record of a total 3,936 full five-day weeks - weeks this bad have only happened in 0.28% of times, she said.
To put last week’s loss in context - last week was the worst since the week ending Oct. 10, 2008 when the S&P 500 lost 18.20%. But it was the third worst week since the week ending Sept. 21, 2001 when it lost 11.6% while the week ending Oct. 23, 1987 that lost 12.2% was the only other week as bad as last since the week ending May 17, 1940 with a loss of 15.39%.
Here’s what historically happens after a five-day week with a loss of 11.49% or more for the S&P 500, counting Monday to Friday. On average, the S&P 500 returns have been the following:
-0.33% after three days. The maximum three-day loss was 7.74%, the 86th worst on record. The maximum three-day gain was 12.55%, the 17th best on record. Three-day returns were positive 40% of the time.
+ 3.6% after five days. The maximum five-day gain was 10.96%, the 70th best on record. Five-day returns were positive 80% of the time
-1.42% after 30 days. The maximum 30-day loss was 12.88%, the 635th worst on record. The maximum 30-day gain was 16.37%, the 196th best on record. Thirty-day returns were positive 40% of the time
+ 5.85% after 90 days. The maximum 90-day gain was 53.00%, the 67th best on record. Ninety-day returns were positive 60% of the time.
+ 19.13% after 180 days. The maximum 180-day gain was 66.81%, the 18th best on record. One hundred eighty-day returns were positive 100% of the time.
+ 20.75% after 250 days. The maximum 250-day gain was 113.46%, the 31st best on record. Two hundred fifty-day returns were positive 70% of the time.
Pullbacks Are Buying Opportunities
Investors are generally risk averse when there is uncertainty in the market, said Cruz.
For investors who were waiting for a pullback in large cap stocks such as Apple (AAPL) - Get Report, Disney (DIS) - Get Report or Microsoft (MSFT) - Get Report, now is a good time to “step in and use it as an opportunity,” he said.
“This is a small bump in the road and will be in the rear view mirror in 15 to 20 years,” Cruz said. “Stocks don't go on sale for no reason. Follow your investments closely so you can learn to spot opportunities when they present themselves. There is some frothiness day-to-day or month-to-month.”
When companies revise their estimates for this quarter, investors should be prepared.
“I expect more volatility,” he said. “We will continue to see more negative headlines, but don't let it freak you out and hit the panic button.”
Utilize your cash position to buy additional stocks over a period of time, said Thomas Hayes, chairman of Great Hill Capital in New York.
"We take the cash we want to redeploy and break it up into five to 10 units," he said.
During the days the market is down, his firm adds high quality stocks such as large caps that have fallen more than the indices, but still have superior fundamentals. When the market is positive, his company waits and watches for the next "red day when we can put another slug of money to work," Hayes said. "While this may not be for everyone, it's how we think about risk. If the market falls further, we are happy because we can add more, if not, at least we were able to put some cash to work while things were on sale."
Why Going to Cash is a Fallacy
Selling your stocks and going all to cash is still a fallacy because inflation remains at 2% while interest rates for savings and money market accounts are under 2% currently, Underhill said.
One of the biggest myths is that cash is king because over the long run, holding significant amounts of cash ensures that one will suffer significant opportunity losses, said Robert Johnson, a finance professor at Heider College of Business, Creighton University in Omaha, Nebraska.
“Investing conservatively allows one to sleep well as there isn’t much volatility,” he said. “But, it doesn’t allow you to eat well in the long run because your account won’t grow much.”
Large cap stocks like the S&P 500 returned 10% compounded annually from 1926 to 2018. Over that same time period long-term government bonds returned 5.5% annually and Treasury bills returned 3.3% annually.
“To put it in perspective, $1 invested in the S&P 500 at the start of 1926 would have grown to $7,030 with all dividends reinvested,” he said. “That same dollar invested in Treasury bills would have grown to $21.17.”
Why Timing the Market is a Fool’s Errand
Selling your equity holdings after a large market decline and getting back into the market in the future is often a fool’s errand.
Rather than shifting your portfolio to cash or other assets, most investors are better off maintaining their original portfolio allocation, said Evan Kulak co-founder of Polaris Portfolios, a Chicago-based financial planning firm.
"Market timing based on headlines almost always results in subpar returns,” he said. “If investors are worried about their portfolio they stay away from marketing timing and instead stick to their plan or consult with their financial advisor."
It’s times like these when investor resilience is really put to the test, said Mike Loewengart, chief investment officer at E-Trade Financial, an Arlington, Virginia-based brokerage company. “Timing the market is the biggest mistake we see investors make especially when panic sets in.”
Long-term investors find that it is challenging to find the right opportunity to get back into the market.
“It is much too difficult, if not impossible to properly time when to get out of a declining market and when to get back in when the fog or downturn has lifted,” said Mark Hamrick, senior economic analyst for Bankrate, a New York-based financial data company.
Selling during massive downturns means investors “accomplished one thing above all else: they locked in their losses,” he said.
Investors who sat on the sidelines after the financial crisis also missed out on some of the tremendous gains we’ve seen from this bull market over the past 10 years.
“History has shown that significant volatility is often followed by some of the strongest single days for equities and missing out on even a handful of those days can diminish the results for long-term investors relative to what they would have returned had they stayed fully invested,” Loewengart said. “Long-term goals trump short-term volatility.”
Investors should opt to maintain their original allocation by rebalancing, said Sally Brandon, vice president of client services at Rebalance IRA in Palo Alto, California.
“Something we consistently tell clients is that getting into the business of trying to pick the right time to get into and out of the market is a loser's game,” she said. “You have to get the timing right twice and no one I've ever known or heard of has done that consistently over the time frame we care about.”
The amount of time investors spend in the market beats timing in the market, Underhill said.
“Stay fully invested,” he said.
Stick to Original Strategy
Investors need to determine their investment strategy before a political or economic event causes a large pushback in the market.
“This is why we urge people to consider these issues before a downturn, not during one,” Hamrick said.
Most investors opt for dollar-cost averaging in their retirement accounts, a strategy where they invest the same amount of money once or twice a month.
Investors who follow this strategy find that downturns in the market are opportunities to buy more shares because when the market goes up again, you buy fewer shares, so “on average your long-term cost is less than the average price,” Gunzberg said.
If you chose to sell, you need to have a strategy for getting back into the market before an event occurs.
“Getting out now without a plan to get back in is a recipe for losing money,” said Chris Chen, a CFP and CEO at Insight Financial Strategists, a Boston-based financial planning firm. “Humans are terrible at market timing. Now that we have had a 10% or so correction, could it be over? Maybe or maybe not.”