Five Keys for Surviving a Market Downturn; Weekly Updates March 2, 2020

Last week, investors moved from a “reality check” to a “gut check” as the selloff from the previous week accelerated sharply. The coronavirus continued to expand rapidly in South Korea, Italy, and Iran. Even though China’s number of new cases continues to drop, the virus keeps producing new cases in additional countries, including the U.S. The data underscores the steps being taken to limit the spread, but the virus has been difficult to contain. 

Key Points for the Week 

• The coronavirus continued to expand to more countries, shattering the optimistic view from two weeks ago that it was being controlled.
• Stocks dropped sharply on the news, while bonds rose in response to falling interest rates.
• The global decline in stocks reflects the rapid flow of information and the global supply chain that consumers depend on.

This commentary originated on Carson Wealth here.

Earnings and economic expectations seem poised to decline as the virus spreads. Companies continue to announce they are no longer standing by previous expectations of growth. Supply worries from the low production in China coupled with lower demand have pushed corporate expectations significantly down.

The weak markets created a series of significant drops in the S&P 500 and other stock markets last week. The S&P 500 lost 11.4%, pushing it 12.7% below its recent all-time high. The correction, meaning a decline of more than 10%, happened in the shortest number of days ever. The MSCI ACWI sank 10.4%. Bonds benefited from the concerns about slowing growth. The Bloomberg BarCap Aggregate Bond Index climbed 0.8% as the 10-year bond’s yield dropped below 1.2%.

Expectations are the Federal Reserve and other central banks will step in and reduce rates to provide some support for the faltering economy. The Fed’s next scheduled meeting ends March 19, and market expectations are the Fed will lower rates as much as 0.5%. As the accompanying chart shows, expectations are for another cut later in the year. Markets rallied from low levels on Friday when Fed Chairman Jerome Powell released a statement. His words were interpreted as a signal that a cut is likely later this month. Other policy actions could have a similar effect.

Fiscal support may be even more important. We will be watching whether the Trump administration adjusts its funding request to include loans, which is similar to what it offers during a natural disaster. Other countries have taken this step, and communication on how the government would respond could help to stabilize markets.

Five Keys for Surviving a Market Downturn

Global stock markets retreated rapidly last week as concerns about how the coronavirus would impact the global economy continued to worry investors. After enjoying a series of new highs in recent weeks, investors have had to deal with a surge of sharp, negative moves.

When times get difficult, we turn to our five keys to surviving a market downturn. It functions as a guide to help investors weather downturns like the one we are experiencing. Below are the five tips with updates based on today’s markets.

1. Keep the fundamentals foremost.

Market fundamentals prior to the coronavirus update reflected a healthy employment situation, moderate economic growth, and weak, but improving, business investment. In December, the truce between the U.S. and China, a path forward on Brexit, and communication from the Federal Reserve provided great clarity to the markets on major risk points.

The clarity contributed to stocks being more vulnerable than normal to a negative shock. Markets were riding a wave of increased optimism as major issues were being resolved. The last move in the S&P of 1% or more occurred in October 2018. Investors were confident things were moving in the right direction, and the market reflected it.

Stocks were also vulnerable because valuations were above average. The big market recovery last year occurred without corresponding growth in earnings. The coronavirus is undermining an expected earnings recovery in 2020. Because the world is more integrated, both the disease and financial impacts are spreading. Each new country that reports infections raises uncertainty about how long it will be until the economy rebounds. The S&P 500 has been expected to grow earnings nearly 10% this year. Valuations had anticipated the earnings improvement. As the market climbed to new highs in 2020, the price-to-earnings, or P/E, ratio based on expected earnings topped 19 for the first time since 2002 before falling to more normal levels with the recent decline.

The overall employment situation continues to be strong, and the decline has helped move the market toward more normal valuations. The positive economic trend seems intact but more uncertain.

2. Know the cause of the downturn.

The global economy has transitioned from increased clarity on major issues to high uncertainty in a matter of weeks. The coronavirus has raised uncertainty about global growth by undermining supply chains, decreasing demand, and raising the risk of companies experiencing financial stress from lost revenue. The surge in cases, changes to earnings guidance, and uncertainty around how the disease is spreading so quickly have undermined investor confidence.

The coronavirus’s rapid spread to more countries just as the Chinese seemed to be making progress was the most direct cause of the downturn. When the virus was initially reported from China, markets dropped. The Chinese seemed to be containing it, and two weeks ago there were more cases on the Diamond Princess than there were in the rest of the world, excluding China. But the surge of cases in South Korea, Italy, and other countries undercut the positive narrative that had moved the S&P 500 to a new high on Feb. 19.

The global supply chain for some goods is missing key links and people. China is a significant producer of goods used by other manufacturers. Goods aren’t being sold because of a shortage of necessary parts. As more countries are affected, those challenges are likely to increase. Demand is also lower. Tourism has declined, conferences are being cancelled, and people are staying home more. The lost production and lost consumption has made the fundamentals less certain.

Past epidemics have created similar reactions of reduced consumption. Once the disease runs its course, consumption snaps back sharply, and the economy returns to growth. Past concerns about diseases spreading have generally been short-lived. First Trust research shows the S&P 500 is 8.8% higher on average six months after an epidemic. But most of those epidemics affected far fewer people in a smaller region. The scale and uncertainty have made it harder for investors to identify when the selling has been overdone and the markets offer better value.

History suggests markets will bounce back, but there is always risk this virus will prove more challenging to contain.

3. Volatility is like grapes; it comes in clusters.

Investing involves risk and uncertainty. Even when markets are calm, risk is present. Some of those risks, like trade, are known, and some are unknown. The coronavirus falls into the second group. A disease is spreading very rapidly, causing fatalities, and efforts to contain it aren’t working. As soon as new information is available, markets react immediately. Given these challenges, it is no surprise markets became volatile.

When markets become volatile, that volatility may remain for an extended period of time. Technology has improved information flow, meaning everyone gets bad news quickly and at the same time. When the official coronavirus data are posted by each country, the world knows instantly. Social media means eyewitness accounts are available to everyone. This access to more information can create sharper moves as more is known and everyone reacts simultaneously. This, in turn, contributes to markets moving together. U.S. stocks are down 12.7% since their recent peak, while other developed markets are down nearly 10%.

4. Eliminate points or dollars from your vocabulary.

Keep a proper perspective. People make money in percentages and lose it in dollars. Putting losses in dollar terms makes them more painful. Remember the market had a tremendous year in 2019, and now we are giving some of it back. Media reports are designed to tantalize: the largest point drop in the Dow Jones Industrial Average’s history or $3.6 trillion lost in market capitalization. These statistics are meant to be powerful but are important to keep in perspective.

Have you thought of how effective capitalism is at producing wealth that 1,000 Dow points aren’t nearly as damaging as they were 20 years ago? The reason the market can give up $3.6 trillion is because the system works, and that kind of wealth can be created. If you are struggling with the markets, try to avoid watching them on a regular basis. The average person feels much more pain from a loss as they do joy from a gain of the same percentage. No sense making yourself miserable by talking about dollars instead of percentages.

5. Make any changes in a strategic way.

If you need to makes changes, make sure you do them strategically. Please, please consult your advisor before making changes to your portfolio, and make sure any changes fit into your plan. Investors often hurt themselves by giving into emotion at the wrong time and pulling assets out of the market. If simply talking it through doesn’t work, small adjustments will often make the ups and downs bearable. The losses are often far less than the gains an investor misses out on when the market bounces back.

Disclosures:

This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.