On Monday, March 16th, the S&P 500 index closed at 2386, a value that was exactly 1000 points and almost 30% lower than its record closing level set less than a month earlier on February 19th. This represented an aggregate market capitalization loss for these 500 companies of almost $7 trillion. Losses on small cap and foreign stocks were even greater over that same time period, in both percentage and dollar terms. Fifteen of the eighteen daily trading sessions between those two dates ended with market moves up or down of greater than 1% from the previous day’s close. Activity in bond markets, which are usually a source of stability, was similarly pronounced. This volatility was a function of the uncertainty surrounding the eventual economic impact of the global COVID-19 outbreak, and it was further fueled by an oil price crash stemming from the failure of Russia and Saudi Arabia to reach agreement on targeted production volumes.
Given the sudden market and lifestyle disruptions we have experienced and which might be expected to continue for several more weeks and perhaps months, it can be easy for investors to lose focus of the fundamental long-term considerations that will ultimately determine their financial success. Before anyone makes sudden shifts in their asset allocation strategies based on recent market actions, we believe it is important to keep the following points in mind:
- Investing based on emotional reactions to the daily news cycle has never proven to be successful and waiting for uncertainty to die down almost always causes investors to miss out on some of the largest upward moves in the market. According to JP Morgan, someone who invested a lump sum of $100,000 in an S&P 500 index fund at the end of 1999 and remained fully invested through all the ups and downs over the next 20 years would have ended up with a value of $324,000 on December 31, 2019. Had that investor missed the 20 best days in the market during that time period, however, his ending value would have been $102,000, gaining almost nothing on his original investment. Three of the 20 best days in the history of the stock market in terms of percentage gains occurred in late 2008 and early 2009, exactly when a lot of investors had decided to sell and wait for ‘a better time’ to invest.
- US government bondholders have greatly benefited from the ‘flight to safety’ of investors selling out of stocks. The yield on 10-year Treasury bonds dropped from 1.92% on December 31st to 1.57% on February 19th, and has fallen precipitously thereafter to below 0.40% before closing March 16th at 0.73%. Long-term interest rates are a function of market expectations for future short-term rates, as well as expected future economic growth. At these levels, bond traders seem to be implying that they expect continued easy monetary policy accompanying weak economic growth for several years. That contradicts the forecast issued by the Conference Board only last week, however, which projects a GDP contraction in the second quarter but a resumption of our steady 2-3% growth rate for the foreseeable future thereafter. Barring a prolonged period of sluggish economic growth and an historically bad bear market in stocks, it is highly unlikely an investor who recently bought a 10-year Treasury bond yielding less than 1% and who holds it through to maturity in 2030 will ultimately be happy with his decision.
- While longer dated US Treasury securities have experienced double-digit positive returns in a very short time period, corporate bonds did not participate in the rally, with both investment-grade and high yield corporates incurring double-digit losses. This is because credit spreads (the risk premium to compensate investors for possible default) have increased considerably from their previously historically tight levels. As a result, the relative values of both high quality investment grade bonds and their high yield (‘junk’) counterparts, have become much more attractive relative to Treasuries. Part of the reason for this can be interpreted as the market’s fear that corporate default rates could sharply spike up, but that would only seem plausible in the event of a moderately severe and prolonged recession which, as noted above, many view as improbable.
- S&P 500 companies earn just over $1 trillion annually. Therefore, the $7 trillion of lost market value in the recent stock sell-off is equivalent to over six years’ worth of profits. This looks to be excessively pessimistic even in light of recent downward adjustments to earnings forecasts. The current projection from a consensus of analysts compiled by FactSet foresees a slight (0.1%) decline in S&P 500 earnings for the first quarter of 2020, but with an acceleration to positive (3.3%) growth in the second quarter and double digit growth by the fourth quarter of this year. With stocks now trading at less than 14 times forward earnings, it is not hard to envision a scenario where an improvement in market sentiment combined with a return to these predicted levels of corporate profitability growth could lead to a massive recovery in stock prices after the current health crisis abates.
- Even if stock prices do not recover to their previous record levels, the dividend yield on the S&P 500 is now over 2.6%, far higher than the 2.1% average of the past 25 years and even more attractive in relation to the current record low Treasury yields. Retirees and other investors seeking a reliable income stream now have more opportunities to access it from quality, value-oriented companies which have a history of steady, growing dividends.
- The value segment of the small cap sector has been the most severely hit portion of the market, losing 39% of its value in three weeks. That segment now trades at less than 10 times forward earnings. Given that small size and value-orientation are historically two of the most reliable predictors of outperformance over long time periods, this might present an opportunity for investors looking to make tactical allocations.
Hubei province in China, the epicenter of the COVID-19 virus, has begun to return to normalcy as newly reported cases have dropped, some travel restrictions have been eased, and economic activity has geared back up. The area was first quarantined on January 22nd, and it still accounts for a majority of the reported cases and deaths to date. For such a densely populated area to have come to this point in less than eight weeks might provide a glimmer of optimism to other areas of the world who are still dealing with the worst of this crisis.
We are living through a viral outbreak that is unprecedented in its scope and impact on the global economy. The direct and indirect costs being incurred in response to it are staggering. At some point the health emergency will be brought under control, and people’s lives and economic activities will return to normal. In making investment decisions, we must guard against the temptation to overweight the short-term, temporary conditions we are facing today, and instead maintain a primary focus on the more important fundamental, long-term economic and earnings growth we expect to return to on the other side of the current crisis.
By Kevin Fruechte, CFA, CFP®, CPWA®
Chief Research & Operations Officer
Olson Wealth Group
Olson Wealth Group is a full service wealth management firm. With wise counsel and clear strategies, our experienced specialists provide tailored approaches that strive to maximize wealth. For more information, please visit OlsonWealthGroup.com
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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual.