"Perception is strong and sight weak. In strategy it is important to see distant things as if they were close and to take a distanced view of close things." ~ Miyamoto Musashi
After an absence of posting in this blog for nearly four years, and in the near-absence of rational information about capital markets and the economy in the media, I felt it was time to bring back The Financial Philosopher.
Today, I am simply sharing information I've recently collected about the impact of COVID-19 on stocks and the economy, along with information I've sent to my clients through other crises over the past 22 years that I've been managing money. Although every bear market and recession is unique, they all have overlapping qualities that provide clues and ques about what to do, what not to do and how to maintain perspective.
Facts on Covid-19, aka Coronavirus
I'll humbly admit that I was one of the coronavirus deniers as recently as mid-February. I compared the virus to the flu and to previous outbreaks. "How could this turn into a problem?", I thought. If 61,000 people died from the flu in the 2018-2019 season in the U.S. alone, what's the big deal with this virus that had "only" infected about 10,000 (at the time)?
But then I looked at the math and did a little bit on my own:
Exponential Growth: After hearing that the infection rate for COVID-19, left unmitigated, can double every 6 days (or less in some cases), I immediately thought of the power of compounding example: Would you rather have one million dollars now or one penny doubled for one month? The correct answer is one penny doubled because it would be worth over $5 million after 30 days. That's 500 million pennies. Now imagine that those pennies are COVID-19 infections. The doubling rate for coronavirus is 6.2. In about 6 months, especially if left unmitigated, coronavirus cases could reach 500 million. If 1% die, we'd lose 5 million lives.
Why "Flatten the Curve": The reason you keep hearing this phrase is not just because we need to slow the spread rate but because we can't afford to risk overwhelming the hospitals. According to the American Hospital Association, there are 924,000 hospital beds in the U.S. With 20% of COVID-19 cases requiring hospital care, we'd surpass full capacity after 5 million infections (keep in mind the doubling rate). If we surpass full capacity, the death rate dramatically increases. Since there are about 100,000 ventilators in the U.S., caregivers will begin having to choose who lives and who dies, as is already the case now in Italy, where they are averaging 500 deaths per day for the past week.
True Cases vs Reported Cases of Coronavirus: It's important to understand the difference between official cases of COVID-19 and the actual number of infections. Thanks to some math from engineer and viral application entrepreneur, Tomas Pueyo (hat tip to TFP reader, Peter W), the number of actual cases is estimated to be 800 times the number of deaths. Think about that next time you see the number of deaths in your community. Now do the math.
Stock Market History: What to Expect, What To Do (or NOT Do)
The following points come from current information I have shared with my clients, along with information I've compiled over the past 22 years I've been managing money:
How bad will the recession be? No one knows this with certainty but according to an Anderson/UCLA study, US GDP for the second quarter is forecast to decline by 6.5%, Q3 will slow by 1.9%, and Q4 will see a return to growth of 0.4%. Morgan Stanley forecasts 2020 recession to be more severe with total 2020 GDP falling 8.8%. This is almost Great Recession levels but not near Great Depression severity.
How long will the coronavirus last? No one knows this with certainty, either, but we do have data from other countries. China and South Korea have already begun recoveries and are beginning to normalize. Last week, China reported ZERO new domestic COVID-19 cases and they are normalizing Wuhan and Hubei; South Korea reported more recoveries than infections for three consecutive days. Based on these cases, if the U.S. can ramp up the testing and maintain social distancing, we will see a dramatic rise in infections through the first half of April and a leveling off and decline of new infections in May.
Yes, there are bullish investors now: According to a memo from one of my finance editors, never in the history of time have more people searched “stocks to buy” than at 10:00 AM (EST) on Thursday, March 12 (the S&P opened down 10% in that hour). The second most popular time for this search term in the history of Google was 10:00 AM on Monday, March 16 (the S&P opened down 13% in that hour).
Dollar-cost averaging: Although the bottom for stock prices may not have been seen yet, long-term investors can "dollar-cost average" down in increments. For most people, the best way to accomplish this is to continue regular contributions to retirement plans, such as 401(k) plans and IRAs. The more purchases of stocks and stock mutual funds you make at lower prices, the faster your pre-crisis balances will be restored. Other investors may want to "nibble" on beaten down stocks. Technology and health appear to be sectors that are oversold now.
Keep a long-term view: As of the end of trading March 23, 2020, stocks were down 32% from the most recent highs in February. That’s the “headline number.” But dig deeper and you see the proper perspective, which never looks at a one-month return. Through March 23, stocks (the S&P 500) had an annualized 10-year return of 8.80%. Depending on what history you analyze, this is an average to above-average long-term return.
Long-term investors need to ignore all of the returns in the following chart, with exception of the 10-year. If you're retired or nearing retirement, you should have 3-5 years of income in bonds and cash:
|
1-Yr |
3-Yr | 5-Yr | 10-Yr | |
| Stocks | -18.51 | 0.34 | 3.26 | 8.80 |
| Bonds | 6.50 | 3.94 | 2.80 | 3.47 |
| 60/40 Balanced Portfolio | -9.91 | 1.60 | 2.87 | 6.80 |
Returns as of March 23, 2020. Stocks = SPY, Bonds = AGG, 60/40 Balanced Portfolio = VBIAX
Always remember mean reversion: Asset prices eventually revert to the mean. For example, as of December 31, 2019, the S&P 500 index had a 10-year annualized return of 13.5%. Experience should have told any sane money manager that prices would have to revert to the mean at some point. Looking at all of the 10-year returns above, stocks, bonds and balanced portfolios are now about where they should be, if not a bit lower.
You’re not 100% invested in stocks: Typical investors have an asset allocation of roughly 60% stocks and 40% bonds. For reference, see the “Balanced Portfolio” in the above chart. Compare -9.91% annual decline to the -32% drop for the past 30 days. Perspective!
My 3-year rule: On average, it takes 3.3 years for stocks to recover from a bear market. This is why, for retirees currently withdrawing from investment account(s), it's wise to have at least three years of income in some combination of cash and bonds.
Time in the market beats timing the market: You've probably heard the saying, "Life is 10% of what happens to you and 90% of how you react." It's the same with investing (although when you react also applies). Between 80% and 90% of the returns realized on stocks occurs in less than 10% of trading days. So, if you're out of the market when stocks have the biggest gains, your long-term returns will be significantly lower. For example, between 1986 and 2005, the S&P 500 compounded at an annual rate of return of 11.9%--even after factoring in the market crash in 1987, two recessions, two wars, 9/11, the 2000's "tech-wreck," accounting scandals (i.e. Enron), and more. Due to market timing (selling at inopportune times), the average investor's return during that time was only 3.9%.
Reflecting Back, Looking Forward
Reflecting back on market and economic crises over the past 22 years, I have found that the greatest investment returns are not as much a product of selecting the right investments or even the right timing; but more a product of the right investment behavior. A majority of any given portfolio's returns are impacted by asset allocation (your mix of stocks, bonds and cash) and the timing of purchases.
Remember the past and apply the lessons you learned to your present and future. This is a universal truth that applies to much more than investing. Another universal truth: If you learn, you don't lose. If you've never been through a major market correction or a severe economic recession, use this time to learn. This doesn't mean that you become more cautious and learn to survive but that you grow more courageous and learn how to live.
Kent Thune is a philosopher who happens to be a Certified Financial Planner (TM) and owner of Atlantic Capital Investments, LLC, a registered investment advisory firm located in Hilton Head Island, SC. Mr. Thune is also a freelance writer published on multiple investing and finance websites, including MarketWatch, Yahoo Finance, Kiplinger.com, InvestorPlace.com, and The Motley Fool. When not advising clients or writing articles, he provides financial counseling to Marines and other service members on Parris Island.
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