The "V" Shaped Recovery
In March, we watched in horror as the market plummeted over 35% in a short series of days in reaction to the coronavirus. Americans who were overseas scurried to get home before the borders closed, those who were in the US ravaged stores for food stuffs, personal protection equipment, and toilet paper. It was a wild and crazy time.
Many times, we have pled the case that if we are going to invest in the stock market, we must embrace volatility. It is the very fact that the markets fall, precipitously at times, that allows for equity returns to be higher than the risk-free rates earned on money markets and savings accounts. Heightened levels of uncertainty are when the best investment opportunities show up. This is because timid and ill-informed investors bail out, leaving significant growth opportunities for those who stay the course. To survive these falls, we must prepare ourselves financially, but more importantly, we must prepare ourselves emotionally. The past two years have been an outstanding training ground for learning the lessons of successful investing.
How do we prepare for the certainty of down markets? First, ensure that you have the time necessary to recover from a down cycle in the market. Have enough safe and liquid assets, free from the vagaries of the market, to allow for stock prices to recover from their fall. How much short-term safe money you need is not just dependent on your spending needs, but also on your own risk tolerance. For individuals prepared to stay the course, risk is simply not having enough money when you need it. This differs from the definition of risk used by institutional investors, which is based on short-term market volatility, and that is a very important distinction.
Recently, Wayne Thorpe, senior financial analyst at The American Association of Individual Investors Journal, shared the following statistics. Since 1871, market downturns have recovered as follows:
- 33% of market downturns recover within a month
- 50% of market downturns recover within two months
- 80% of market downturns recover within one year
- 95% of the time those big “once or twice in a lifetime drops” return to even in three to four years
- Collectively, since 1871, the time it takes for the market to recover (top to trough to top again) is a mere 7.9 months
Understanding the history of market recoveries can help you decide how much safe money you need to set aside as an insurance policy. We usually suggest three years of reserves. Staying the course in a year like 2020 takes nerves of steel and the temerity of James Bond, or a well thought out plan to stay committed no matter how gut wrenching the news of COVID deaths, virus resurgence, unemployment, severed supply chains and school closings gets.
Though we’re still fighting the virus and we’re in an on-going recession, with only three months left in 2020, it seems like we’ve seen it all. The economy appears to be on the mend and the stock market is fully recovered.
When comparing the three most recent bear markets, the Covid-19 Panic took the market down 35% in 23 trading days. It only took 97 trading days to recover and reach new all-time highs. The bursting of the housing bubble and the subsequent Great Financial Crisis took the market down 55% in 355 trading days and took 1,678 trading days, or more than 6.5 years, to get back to all-time highs. The bursting of the Tech Bubble took 525 trading days to drop 47% and another 1,000 days, or 4 years, to get back to all-time highs. The Covid-19 Panic and recovery has been decidedly “V-shaped”.
Covid-19 lockdowns forced companies to respond by laying off employees. Initial job losses were a staggering 22,000,000, and the unemployment rate spiked to 14.7%. Since April, employment has rebounded sharply, with over 10,000,000 jobs added back since the lows of March and April, taking the unemployment rate back to 8.4%. So far, the recovery in jobs has a distinct “V-shape”.
The Covid-19 panic caused US Retail Sales to collapse by $82 billion, or 17.5%, in 3 months. But sales recovered back to all-time highs by July 2020. eCommerce has been the major benefactor during the coronavirus. With every retailer forced to sell goods online, it will be interesting to see if Amazon.com remains the dominant player.
The real output for factories in the United States tumbled during the initial Covid-19 panic. Non-essential businesses were shuttered and supply chains were disrupted. Output shrank by 16.5% through April 2020. Since then, output has recovered strongly, reclaiming 57% of lost output.
Rebounds in the stock market and other areas of the economy have surprised a lot of people, forecasters included. There have also been many aspects to the current crisis that are different than past downturns. Unemployment tends to spike at the end of the recession, not at the beginning. There tends to be a much slower grind lower in the stock market, as bad news continues to slowly roll in. Yet, during the current recession, the bad news came fast. It tanked the stock market and every other key economic indicator at a speed and degree we’ve never seen before. Equally amazing was the size and degree of the stimulus provided by the Federal Reserve. They injected $3 TRILLION of liquidity into the markets.
Extreme stimulus has helped the stock market recover quickly. The Federal Reserve seemed to pull every lever available to them; they even contracted with BlackRock to buy bond funds to support bond prices. Without the help of the central bank, it’s unlikely the market would be back to all-time highs in such short order.
Here is what you should remember from this exercise: When you read headlines that strike fear in the hearts of mortal humans, remember that it is only temporary. The over-hyped concerns and pessimism constantly promoted in the news is a technique to sell more papers and earn more clicks. It is critical for investors to distinguish between compelling story telling and hard financial metrics. Then smile a little, and rest easy knowing that doing nothing, is in fact, doing something. Yes, the next time could end up worse for the year, but a year is temporary. Remember this too: If it hasn’t ended well after a certain period of time, then it isn’t over yet. Optimism is a far better approach to investing than pessimism, though pessimists do get more attention, and somehow sound more believable than optimists, a reality we can’t really explain.
If you are conscious of the price that you are paying for something and have the necessary skills to make that determination, then be confident of your calculation. If you have conservatively budgeted for 3-4 years of living expenses for those “once in a lifetime” drawdowns, that seem to happen quite frequently, then continue to live as if nothing is happening in the markets. If you know that the best minds in the world are working on the problems from many different aspects, give them time to do their professional magic. If you are patient, if you are an optimist, if you understand how and why news is generated, then there is no reason to practice the debilitating exercise of market timing. Market timing is an impossible dream. We all want to do it, but it never seems to work.
Perhaps this last chart really says it all. The worst performing asset class for this year and for the last 10 years is US small cap, especially US small cap value. However, the growth of $1 for various US asset classes for the period of Jan. 1926 to Aug. 2020 shows an entirely different result. For this longer, but more relevant investing period, small cap stocks beat large cap stocks 3 to 1.
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