Light at the End of the Tunnel

I noticed a significant milestone during this current bear market yesterday as I was putting the finishing touches on a new client’s portfolio. But before talking about the markets, I have a short digression.

Naming adverse events can help us identify the problem, digest, cope, and take action. There is also evidence that naming fears reduces their power over us. As a result, our society names many things from hurricanes to virus strains. For example, naming the virus SARS-CoV-2, coronavirus, or novel coronavirus and the disease COVID-19 is accurate, useful, and concise. We've identified what it is, and the name gives scientists clues on how to combat it. Calling it “Chinese Flu” or “Kung Flu” at best is not helpful. At worst, it is a despicable act of xenophobic fear-mongering. I encourage you to avoid using this type of language, stay positive, and focus on how we can all overcome this challenge. 

Now, back to the current bear market. Since it helps us to name scary things, let's call it Bear Market 2020 or BM-2020 for short. Yesterday’s bear market milestone was the US stock market (measured by the S&P 500) declining about 33% from the all-time high close on February 19th (3,386) to the middle of the day low on March 18th (2,281). No doubt, BM-2020 has been challenging on many levels. Below are a few reasons why this bear market has been especially difficult.

• BM-2020 has been the fastest time to a bear market (20% decline from previous high) in history.

• Similar to 2008, bonds and stocks declined in value, though bonds not nearly as much (5%).

• The world is in the midst of a pandemic.

• Information and disinformation move at lightspeed today, possibly making the pandemic feel worse.

• People’s lives are changing dramatically - closing schools, working from home or, more concerning, not working at all.

Why I Am An Optimist

With all these reasons to be down, why in the world am I an optimist? These are my top five reasons.

1 - The measurable benefits of investing in the stock market after a decline outweigh the downside.

For example, even if you believe BM-2020 will reach a 50% decline, the numbers are in your favor. A total drop to 50% from here is an additional 25% decline (yellow box below). Meanwhile, a recovery to the previous high from here is 50% (green box below). Will the market decline further? Maybe. Has the US stock market recovered from every other bear market in history and continued to grow over time? Yes. 

The table below demonstrates the asymmetrical nature of “rise to recovery” value after a market decline from 33% down. And if someone believes they will get out now and come back in at a lower price - A) good luck, and B) the upside is already in your favor to stay put or rebalance to long-term target portfolio allocation.

2 - Bear markets are part of the long-term investment cycle.

According to Ned Davis Research and summarized by Franklin Templeton below, there have been 18 bear markets from 1960-2018 with an average decline of 26% over 11 months. Despite these periodic pullbacks, “the Dow” has grown from 679 to about 20,000 today.

3 - Bear market recoveries have a positive skew toward higher growth.

The chart below from Michael Batnick, CFA shows the average return for the S&P 500 following market declines since 1950. At a 30% decline or more, the 1-year and future returns look pretty appealing. I agree with Michael’s point that

Once stocks fall 20%, long-term returns start to improve with every painful leg lower. This is why it’s so important to stay in the game. Nobody ever said you have to have all of your money in stocks, but you can’t be all cash either because lower returns today plant the seeds for higher returns tomorrow.

4 - We have experienced pandemics in the past.

For example, flu pandemics in 1957 and 1968 both resulted in over 100,000 deaths in the US and over 1,000,000 worldwide. Hard to imagine, right? Unfortunately, COVID-19 has the potential to be worse. However, our biotechnology, knowledge, and resources are incredibly more advanced than it was 50-60 years ago. It may take some time, and there will probably be some bumps in the road, but we will get through this. We may even learn some lessons and be better prepared for when the next pandemic hits. 

• https://www.visualcapitalist.com/history-of-pandemics-deadliest/

• https://www.cdc.gov/flu/pandemic-resources/pandemic-timeline-1930-and-beyond.htm

5 - While I expect the COVID-19 situation to worsen in the US before it gets better, there are some positive developments we need to keep in mind.

Below is an abbreviated list of positive COVID-19 developments from https://www.goodnewsnetwork.org/10-positive-updates-on-the-covid-19-outbreaks-from-around-the-world/.

1. US Researchers Deliver First COVID-19 Vaccine to Volunteers in Experimental Test Program

2. Distilleries Across the United States Are Making Their Own Hand Sanitizers to Give Away for Free

3. Johns Hopkins Researcher Says That Antibodies From Recovered COVID Patients Could Help Protect People At Risk

4. South Korean Outbreak Finally Abating as Recoveries Outnumber New Infections for Three Days in a Row

5. China Celebrates Several Milestones of Recovery After Temporary Hospitals Close and Parks Reopen

6. Australian Researchers Testing Two Drugs as Potential ‘Cures’ for the Virus

About That Tunnel

So we've seen over the last month, the number of documented COVID-19 cases and deaths have increased, the stock market has declined by about 30%, schools have closed, many people are working from home, and many are not able at all. Despite these challenges, I see the light at the end of the tunnel. How long this tunnel is, I don’t know. But I’m confident we’ll get there together.

Be smart. Be safe. Be well. Be positive. We Got This.