The COVID-19 pandemic has made lockdowns, quarantines and “social distancing” the norm in much of the world. Violent moves in the market have become commonplace, a natural response to uncertainty about the spread of the virus and resultant impact on economic growth.
Although it is understandable to think of market volatility as an unusual occurrence, meaningful downturns in the market are common. Since 1980, the S&P 500 has experienced at least an intra-year drop of 10% in 23 years and a 15% or greater drop in 15 years. Despite frequent intra-year downturns, calendar year returns for the S&P 500 were positive in 30 of the past 40 years. Unfortunately, the magnitude of this year’s equity selloff makes a recovery to positive territory seem unlikely in 2020.
The temptation to time the markets is hard to avoid, but market timing is usually a recipe for failure. Morningstar’s annual study of 20-year returns illustrates the perils of market timing. Investors in the U.S. equity market for the full 20-year period through the end of 2019 earned 6.1% per year, while investors who missed the 10 best days saw their returns drop to 2.4% per year. Although avoiding the 10 worst days would boost returns, the best and worst days tend to be clustered together. Unfortunately, there are few (if any) investors able to trade with the perfect foresight to capture the upside and avoid the downside.
Calling the bottom in the COVID-19 crisis will be extremely difficult. Investors will be looking for a slowdown in the number of new Covid-19 cases, progress in the ability to treat victims of the outbreak, and early indications that people can resume normal living. Government policy to prevent near-term liquidity issues from becoming long-lasting solvency issues will also have an important influence on investor sentiment. With uncertainty remaining at extreme levels, it seems foolish to make any bold declarations about the near-term direction for equity prices.
However, market dislocations can often provide company-level buying opportunities; there is a profound difference between making incremental portfolio changes in response to market volatility and “all-in/all-out” strategies to try to call market tops or bottoms. Benjamin Graham, the “father of value investing,” stated, “The day-to-day market isn’t a fundamental analyst; it’s a barometer of investor sentiment.” Emotional swings are often disconnected from fundamentals, creating divergences between price and intrinsic value. Investors with a well-informed point of view can take advantage of panic-driven situations to buy stocks that are temporarily undervalued or sell stocks that are temporarily overvalued.