A friend of the family sent an email to my wife on Friday asking if she should sell all of her stocks because they are performing terribly. I wonder how many average investors are having similar thoughts or discussions this weekend as they check their 401K and other financial statements.
There is no doubt about it the stock market got its rear-end kicked this past week. If you held a $1 million portfolio in an S&P 500 index fund you saw your portfolio lose over $100,000 in one week.
Expect more volatility – with big swings up and down – over the next few months.
I am not immune to the pain. My dividend portfolio, which is a little over 50% in cash, lost over 5% this week and is 7% down from its high. My advisor-managed portfolio, which is diversified among a series of asset classes, is only down a little over 1% from its recent high. All-in-all, I was down about $30,000 last week. If all of my investments were in an S&P500 index fund I would have been down over $250,000.
Back to the question, time to panic sell? No. I am actually going to begin to use some of my cash to buy into this market. You can see my recommendations on what to do below but first we should talk about the difference between a stock market correction and a bear market.
We are in a stock market correction and the average stock market correction recovers in 4 months.
A stock market correction is defined as a 10% decline in one of the major U.S. stock indexes, usually the S&P 500 or Dow Jones Industrial Average, from a recent 52-week high close.
Last week we entered into a market correction with the S&P 500 and the Dow Jones Industrial Average. Both fell by over 12% from recent all-time highs.
There have been 26 market corrections (not including this one) since World War II with an average decline of 13.7%. Recoveries from stock market corrections have taken four months on average. The most recent correction (not including this one) occurred from September 2018 to December 2018. The major indices were out of correction territory and up again by the second/third quarter of 2019.
This past week we saw the fastest market correction in history, with the S&P 500 taking less than a week to drop by 10% from its all-time high. The average stock market correction takes over three months to see a 10% drop. This could mean a quick recovery if everything that is uncertain and causing the drop turns up aces.
But watch out for the bear market in terms of expectations of a recovery. Recovery timelines get much longer, and the pain gets much worse, if we enter bear market territory.
The Bear Market Risk – the average bear market lasts more than a year and takes more than two years to recover.
The stock market enters a bear market if there is a 20% decline from a recent 52-week high close. We are not there right now but reset your expectations on how low the market will go and how long it will take for the stock market to recover if we enter a bear market.
There have been 12 bear markets since World War II with an average decline of 32.5%. The most recent was October 2007 to March 2009, when the market dropped 57% and then took more than four years to recover. Bear markets have lasted 14.5 months on average and have taken two years to recover on average.
Will this market correction result in a quick recovery or a bear market?
The main reason behind the current market decline is growing concern surrounding the spread of the coronavirus. We don’t know how this will end, except to say that to-date all pandemics have eventually been contained and the stock markets have moved on, but here are the main things I am paying attention to right now:
- The spread of the coronavirus in the United States: As of today, there are a growing number of identified cases in the United States and two deaths from the virus. The low number of infections and (at the time one death) were being mentioned often by President Trump to try to keep calm. However, you have to ask whether the low numbers are due to the virus not being present in the United States or our country’s woeful inability to test any large numbers of people that may have been in contact with the virus. If you start seeing growing pockets of people infected with, and dying from, the coronavirus in the United States then this could be a negative for the markets.
- Actions by the Federal Reserve: The Federal Reserve chairman issued a short statement Friday afternoon reaffirming that the FED would use its tools to support the economy. In his statement, the Fed chairman said that the “fundamentals of the U.S. economy remain strong” but noted that “the coronavirus poses evolving risks to economic activity.” This was the Fed trying to calm the markets and it will be interesting to see when and how the Fed will try to support the economy to offset the impact from the coronavirus. The market is expecting more interest rate reductions by the Fed and this expectation seems to be working to calm investors in the short-term. Will lower interest rates keep the markets happy if the economy starts to see cracks in consumer demand.
- The U.S. Consumer and the Probability of a Recession: Two stories here – I was at the market this weekend buying Clorox wipes and disinfectants and so were the other 10 people in line with me. However, that same day my family and I went to a park and sports complex and both places were as crowded as ever. People were still talking about going to Disneyland over the weekend and how the park was as crowded as ever. How will the U.S. consumer react over the next month? Will the continue to ignore the virus if the news cycle continue to report growing case in the United States? The U.S. economy is driven by the U.S. consumer (two-thirds of annual gross domestic product, or GDP, is driven by consumer purchases) and if people stop going out and spending then the probability of a recession will go up and this will be another negative issue for the markets. Consumer sentiment is still near a decade long high, but it will not stay that way if the coronavirus significantly spreads to the United States.
- Corporate earnings and announcements leading up to April: With the first quarter of 2020 ending later this month corporations will be having earnings calls beginning in April and may be revising guidance before these calls. If corporations start talking about an impact to the supply of AND demand for their products or services then that will be another negative factor for the market. Right now the talk has been about supply chain disruption but if we start seeing an impact on demand then that is a new issue.
- The Presidential Election: Like him or not President Trump is good for the stock market. Any improved prospects of Senator Bernie Sanders becoming President Sanders due to a worsening economy or a significant spread of the coronavirus in the United States will be a negative factor for the market.
All of the above factors have a positive side to them. For example, if the spread of the coronavirus in the United States is minimal over the next few weeks, the Fed jumps in with a significant rate cut soon, or corporate earnings remain strong in April, then the likelihood of a bear market decreases and a near-term market recovery becomes more likely. Also if, for example, we get concrete good news on a vaccine then the markets should react very positively.
Expect a lot of market volatility while uncertainty around these key questions remains open.
If you can handle the volatility of last week and a potential bear market
When I talk about whether a person can handle the volatility we are seeing in the market I mean two things: (1) does the person have a long enough investment horizon to not need much cash from his/her investments over a 5-10 year period and (2) does the person have the emotional make-up to not sell their stocks and lock-in permanent losses if they see a 20-30% decline in their investments this year?
Assuming you can answer yes to both questions and handle the upcoming volatility then do not do much right now. The market has shown over time that it will rebound (it may take years in the bear market scenario).
If this week was a wake-up call and you cannot handle the volatility with your investments
I would never recommend selling your stocks immediately after a drop like last week but you may want to wait for a market rebound from last week and then decide to sell some of your more volatile stocks or funds and place them into more conservative investments. If you cannot handle another 10-15% drop over the next few months (either because you will make a bad emotional decision and sell or because you need more certainty with your investment principal due to age, etc.) then consider a better allocation of your investments so a portion of your assets will not see a loss in principal if we go into bear market territory.
If you have cash-on-hand and have been waiting to use it for the next downturn
If you have cash-on-hand and have been waiting to use it when the market goes down I assume you have a or are putting together a plan to invest when the time comes. Be logical and not emotional and remember we do not know if this will be a quick recovery from a market correction or a bear market. There are a lot of open questions so be patient with your buying.
I am following my own Recommendations
I do have some cash-on-hand and I got out the list of companies I want to buy when there is a significant market pull back. I sold some put orders on Friday and I put in my first buy orders this morning to buy some of the stocks I like. I will be making small stock purchases over the next few months. If we do get a bear market I will be making additional purchases. The stocks I am buying pay dividends. I am buying these stocks for the long-run.