By Rich Weiss - As of March 9, 2020
Markets may have panicked today, but we think it’s best if investors respond with poise and patience instead. It’s never a good idea to panic sell or react to market moves in a knee-jerk manner. Instead, risk is something you prepare for and acknowledge before you ever make your first investment.
Historically, “acts of God” tend to exert painful, but temporary and localized market effects. But today, two events hit markets simultaneously—coronavirus fears and oil price drops.
The virus is hurting affected economies, while attempts to contain the disease created barriers to trade and travel. There is simply no way to know how this will play out, but it’s clear that investors fear this may push the U.S. and the world into recession.
Meanwhile, we’ve seen a dramatic decline in oil prices since the weekend. The COVID-19 outbreak has already hurt global oil demand. Now, price disagreements between Russia and Saudi Arabia are causing prices to fall even lower. While lower oil prices benefit consumers by making gas and other energy input prices cheaper, in the near term, energy companies and support services take an economic hit.
Energy is one of the big sectors of both stock and bond markets, so that explains some of the decline we’re seeing. But oil prices are also considered a proxy for the health of the global economy—when prices are up, the economy is doing well. So, today’s huge decline shows investors are worried about a potential recession.
Stock returns are a function of dividend payouts, corporate earnings growth, and the price investors are willing to pay for that growth (P/E ratio). Stocks sold off today because investors fear a potential recession would hurt earnings growth in the near term. Since it’s not clear when the disease will be contained or what long-term effects it may have, it’s difficult to determine a reasonable rate to pay for earnings going forward.
Combining assets that perform differently during similar market environments has the potential to improve your risk-adjusted return. The current market meltdown shows that your best defense against market panics is diversification. It won’t assure a profit or protect against loss of principal, but it will help you manage risk.
Some investments zig when other zag. For example, investments that many people consider to be safe havens are currently holding up better than stocks.
This type of market turmoil is an acid test for gauging how much risk you can handle. It’s possible for stocks to lose 15-25%--or more—over short periods of time. If you can’t resist the temptation to sell now, it may be a sign that you aren’t comfortable with your current level of risk. It may be time to reconsider your portfolio makeup.
Of course, this year does not look like the last 10 years. For investors new to markets in the last decade, or for those who simply forgot that markets can also go down, this period is an important reminder that risk is real. Risk is what happens when the market becomes complacent and acts as if stocks can only ever go up.
It’s also probably worth saying that this is not 2008—today’s banking system is in much better shape than it was a dozen years ago. Regulators and decisionmakers, too, learned the lessons of the Financial Crisis and are better positioned to respond today.
The coronavirus is an unqualified human tragedy for thousands of people. Its human and economic effects cannot be known in advance. So, people are understandably scared and anxious about the disease’s future trajectory.
But as bad as this situation may get, we believe we will overcome it. A treatment or vaccine is likely to be found at some point, and the global economy will recover. There’s light at the end of the tunnel, and we encourage investors to patiently hold on. We believe it pays to focus on what we do know, and on factors we can control. These things include how you diversify your portfolio, how much risk to take and your buy-and-sell decisions.
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References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
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