- The market has cycled through many peaks and drops over the last 25 years
- Not every market labeled a bear market meets the same criteria or lasts as long
- The catalyst of this potential bear market isn’t the economy; it’s a swift-moving virus
- Investors have a tried and true playbook for volatile times: diversification
After 11 years of bull market conditions, a perfect storm around the new coronavirus has pushed markets into bear territory. Contributing factors include the World Health Organization (WHO) officially declaring the COVID-19 outbreak a pandemic, markets reacting to government policy responses, and containment measures increasing as confirmed coronavirus cases have continued to rise globally.
Given the swiftness by which the coronavirus has spread and how quickly the market has declined, it’s natural for many investors to have concerns about their portfolios. Before you react to headlines, however, it’s important to keep a few key facts front and center, which we’ll discuss below.
In Chart 1 below, you can see how the market has cycled through various peaks (top point of a rising market) and troughs (bottom point of the drops) over the last 25 years, with today’s market declines being the most recent significant decrease since the 2008 financial crisis. The most recent cycle and bull market run spanned from the market’s bottom in March of 2009 up until late February 2020, where the market has now dropped over 30% from its peak.
Chart 1: Stock Market Cycles: Dow Jones Industrial Average since 1995
Source: Clearnomics, Standard & Poor’s
Not Every Market Labeled a Bear Market is the Same
First, it’s important to discuss definitions. Just as the WHO is careful when declaring an outbreak of disease a pandemic, we should be careful in clarifying what it means to be in a bear market. A commonly-agreed-upon definition is that a bear market is a 20% decline in a broad market index from its peak. The Dow closed on Wednesday, March 11, 2020, with a high-to-low decline just over 20%, and other major indices have since followed.
While a 20% decline does meet the dictionary definition of bear market — and trigger bear market headlines — the truest meaning of the term is of a prolonged period of deep market weakness that is almost always tied to an economic recession. Case in point: The average bear market since World War II has had a market decline of 35%, far worse than the standard 20% definition.
This is important because we have seen several near-20% pullbacks (declines) in recent years, including in 2011, when the U.S. debt was downgraded, and again in late 2018, when many economists were forecasting an imminent recession. This is where the term “bear market” becomes tricky. Is a 19.8% decline (September to December 2018) that different from 20%? Should we still call it a bear market if it recovers within a few months?
This doesn’t mean that any market pullback is pleasant or that the situation can’t worsen. It’s simply a reminder that we’ve seen similar declines before, regardless of what we call them.
The Cause Behind Each Bear Market Makes a Big Difference
Second, it isn’t the bear label that causes markets to fall, it’s the underlying cause. In this case, the spread of coronavirus has been swift, resulting in aggressive government actions. In many ways, slowing the spread of the coronavirus via social distancing and other measures is an attempt to immunize society but has side effects that harm the economy.
This is the heart of the issue. Markets are built to “price in” all available information. This means that investment prices (values) tend to reflect all the known economic, social, and political factors out there. It’s true that if the economy is disrupted, then growth, profits, and cash flows may fall. However, what happens when the information available is rapidly changing, and there is general uncertainty like there is now?
Unfortunately, significant uncertainty, especially in the absence of relevant historical guidance, makes it difficult to assign a value to investment assets. This also causes investors to be uncomfortable and often reactive, which is usually is not the best course of action.
In other words: It’s hard to know what to pay today to receive $1 in the future because it’s very unclear what will happen before now and then. So, what do we know?
The Market Was Strong Before the Coronavirus Outbreak
We know that the U.S. economy was strong prior to the coronavirus outbreak, increasing its likelihood of recovery.
We know that the cause of this bear market isn’t inherent to the economy or the financial system. This isn’t 2008 when financial markets seized up or 2000 when valuations were at astronomical levels. There are scenarios where short-term liquidity problems can become long-term issues, but we’re not there just yet.
We know that we will see poor economic readings over the next several months and possibly quarters. This should not be a surprise when it happens.
We know that markets will be sensitive to headlines and government policies in the short run. Ideas such as payroll tax relief, delayed tax filings, small business loans, payments to individual Americans, and more could help minimize the economic impact. The Fed is also expected to take additional measures to try to bolster markets and the economy at its meeting next week.
Investors Have a Tried and True Playbook for Times Like This
Finally, and most important, we know how investors can navigate significant periods of uncertainty, regardless of the cause or how uncomfortable they might be. Holding diversified portfolios that are appropriately tailored to an investor’s financial goals (such as your MoneyLion portfolio is tailored to yours) is the best way to navigate any type of market.
The chart below shows how various asset allocations (stock and bond mixes) performed following the 2008 financial crisis. An all-stock portfolio with reinvested dividends may have done very well until 2007 but would have fallen by nearly half in March 2009. And while it did recover steadily from there, it took until late 2012 to climb out of this deep hole. The biggest problem would have been the temptation to change course at every point along the way (this could lead investors to make incorrect choices when trying to time the market).
Chart 2: Asset Allocation Performance
Total returns of hypothetical stock/bond portfolios since 2007 pre-financial crisis peak using the S&P 500 and iShares Core US Bond indexes, Before Fees & Expenses
Source: Clearnomics, Standard & Poor’s, Refinitiv
This is where being diversified can help. A portfolio consisting of 60% bonds and 40% stocks recovered its full value in only 11 months from the market bottom, an impressive fact. It has performed well since then, even keeping pace with the all-stock portfolio through late 2016. By definition, it has also declined far less in recent weeks.
Those who held only bonds for safety, rather than a more balanced asset allocation, fared well in the immediate aftermath of the financial crisis. However, it’s clear that even in an unprecedented period of falling rates and policy support, this portfolio provided little long-term growth.
While the future is uncertain and the causes unique, there have been many market pullbacks and bear markets in the past. In each case, the best response for long-term investors has been to hold balanced portfolios and stay the course.
For more resources, keep checking the COVID-19 section of our blog here. We’ll be updating it with new information regularly.