The market turbulence of the past six months due to the novel coronavirus has rattled some investors. Not only did the global stock market fall into bear-market territory swiftly, but it bounced back nearly as quickly. While not all parts of the market have done well, there are many lessons for what investors might focus on in the months and years to come.
Three Trends that Matter
Specifically, there are three types of trends that matter for all investments: short-term, cyclical and secular trends. However, they are not all equally important for diversified, long-term investors.
First, there are short-term trends that affect markets for days, weeks or months. For instance, the sudden decline in the stock market beginning in February may have created short-term opportunities for those who were either well-positioned or could take advantage of heightened volatility.
Unfortunately, this period only lasted a few weeks before major stock markets began to recover. Still, for those who are able to keep a level-head, this may create opportunities for investors to buy when the market is cheap.
Chart: This chart shows the S&P 500 during two volatile periods in 2018 and early 2020. It also highlights trend lines that some investors watch to understand which way the market is moving.
One important caveat is that decades of industry and academic research have shown that benefiting from short-term trends is difficult if not impossible. Not only are market moves hard to predict, but they can turn around just as quickly. Additionally, investors tend to be most cautious and concerned when the market is the cheapest. The most recent market episode highlights this perfectly.
Second, there are “cyclical” trends that might affect the market for years or even a decade. In other words, these are trends tied to the expansion and contraction of business and market cycles. There have been three clear cycles over the past 30 years: the tech boom of the 1990s, the housing bubble of the 2000s, and then the post-financial crisis recovery that ended this year.
Although trying to perfectly time the market to take advantage of short-term trends may be alluring, those gains pale in comparison to positioning correctly over the course of a full cycle. In fact, the idea of holding stocks for the long run is rooted in the idea that expansion phases have historically lasted much longer than crashes.
Chart: This chart shows the S&P 500 over the past three market cycles.
Finally, there are longer-term trends that aren’t tied to a calendar. These are often driven by structural changes to the economy, society, or business and consumer preferences. As such, they are perhaps the most important way for investors to construct portfolios over years and decades.
Chart: This chart shows the rise in technology companies – represented by “FAANG” stocks – compared to the broader market. Each index starts from 100 in mid-2015.
For instance, one of the most significant trends over the past two decades has been the growth of information technology. The expanding use of computers, data, telecommunications, cloud computing services, and more have propelled many businesses tied to these trends across many sectors. This has taken places despite short-term market movements and cycles such as the dot-com crash, housing bubble and now the COVID-19 crisis.
This can be seen more recently with the so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google/Alphabet) – a proxy for prominent tech stocks. These stocks have outperformed the broader market by a wide margin not because they perform better in certain parts of the market cycle, but because of their long-term growth potential. Although this is no guarantee that this trend will continue, it’s clear that companies tied to secular themes have been winners during this period.
Thus, the COVID-19 crisis has been a lesson that there are many types of trends for investors to follow. While short-term trends may be tempting, longer-term trends across cycles and secular themes have often mattered more.