Q1 2020 Market Commentary - Be Scared But Don't Be Afraid
We are living through a very scary time right now as COVID-19 spreads across the globe, forcing billions of people to stay in their homes. Back in January, I mentioned the trade war with China, escalating tensions with Iran and wildfires in Australia as scary headlines that might draw too much of your focus. Little did I know, just a few short months later, we would be in the midst of a global pandemic. I think it’s safe to say the headlines have become a lot scarier now. Let’s review what happened in the first quarter, what we learned and where we go from here.
What Happened?
Volatility Returns in a Big Way - If you spent any time watching the markets in March, you might have felt like you were on a roller coaster. There is a good reason for this, as we just witnessed the most volatile month in market history. The average daily change in the Dow was 5.3% for the month, which is well above the record of 3.8% seen in October 2008. The cumulative absolute change for the month was also the highest on record, as you can see in the chart.
Sharp Decline in the S&P 500 - The S&P 500 saw it’s fastest ever 30% drawdown in the first quarter, reaching that level in just 22 days. There was a rebound towards the end of the month, but the 19% overall decline for the quarter was still the worst since 2008. 
Large Cap US Stocks Weren’t Alone - The coronavirus has spread across the globe, so it should come as no surprise that international stocks dropped sharply on the quarter as well. Developed market international stocks fell by 23% while emerging market stocks fell by 24%. Investors expect smaller companies to have a more difficult time getting through this pandemic, and US small cap stocks suffered the worst performance on the quarter with a decline of 31%. Real estate also took a major hit with REITs falling 23%.
What We Learned
Bonds Still Provide Diversification Benefits - As pretty much every area of the stock market sold off in the first quarter, high quality bonds were the lone bright spot. The Federal Reserve cut rates to near zero and investors flocked to the safety of fixed income. The Barclays US Aggregate index finished the quarter up 3.1%, while US Treasury bonds posted even stronger returns. Not all bonds held up well, as high yield bonds fell 15% and some areas of the municipal bond market saw declines. While it has been difficult in recent years to stick with bonds due to historically low interest rates, we once again learned why they are an important diversifier in your portfolio.
You Can’t Always Explain Market Moves - As much as we want to be able to explain why stocks are higher or lower every day, the market doesn’t follow a simple narrative. Read any financial news and you will see “stocks are lower because…” or “stocks rise on news of…” but these are just examples of what is known as the narrative fallacy. As Shane Parrish explains, “The narrative fallacy leads us to see events as stories, with logical chains of cause and effect. Stories help us make sense of the world. However, if we’re not aware of the narrative fallacy it can lead us to believe we understand the world more than we really do.” The market might be pretty efficient over the long run, but in the short-term it is a collection of many different investors with varying goals and opinions, so we shouldn’t try to create a narrative for every market move.
Only In Hindsight Will We See The Bottom - As I write this on April 9th, 2020, we have already seen a 23% rise in the S&P 500 from the March 23rd low. Does that mean we are out of the woods and the market is on its way back to new highs? Nobody knows the answer to that right now, and we won’t know the answer for many years. This chart shows six times the S&P 500 bounced by 9-19% between Sep and Dec 2008, on the way to the market bottom during the Great Financial Crisis. How many times do you think people thought they were at the bottom back then? And how many times did they think they were finally out of the woods and headed back up? It’s important to remember that nobody can predict the bottom and we are just as likely to be in the midst of a bounce as we are a recovery.
Where Do We Go From Here?
We frequently remind you that nobody can predict the future and that has never been truer that it is today. We have seen pandemics in the past, but never at this scale in a globally connected economy. Never have we seen the entire global economy shut down at the same time. Our focus right now is properly on stopping the spread of the disease and treating the sick, but we know these lockdowns are also having a major impact on our economy.
Millions of people have lost their jobs as businesses have been forced to shut down. The government is doing what it can to help, and the passage of the CARES Act, along with another stimulus bill currently in the works, will hopefully provide the financial support needed for many small businesses and individuals to get through this. The staggeringly high unemployment claim numbers we have seen in recent weeks are only the beginning of what will be a stream of scary economic data.
While we know the economy will take a major hit, we don’t know what the recovery might look like. Economists frequently discuss the economic impact using the shapes of letters to describe what could happen. Will it be a sharp “V” shaped recovery where we bounce back quickly? Or a “W” shaped recovery with a quick bounceback, but then further setbacks if the virus re-emerges? Maybe it will be a “U” shaped recovery with a more gradual but sustained recovery?
The shape of the recovery is unknown, but we do know that eventually, the economy will recover. We will not be on lockdown forever. We might emerge from this pandemic into a new world of mask wearing and temperature checks, but eventually we will emerge. COVID-19 is scary and we should be doing all that we can to protect ourselves and each other and to “flatten the curve”. But we cannot live in fear forever.
A scare is a temporary rush of a feeling. Being afraid is an ongoing process. Fear is a state of being.
- Ryan Holiday, The Important Thing Is to Not Be Afraid
There is a lot to be scared of right now, but being scared is not the same as being afraid. It is natural to be scared when unexpected things happen. Being afraid means living in fear of something scary and unexpected happening. You can’t help being scared right now, but you can overcome the fear and identity things you can do to make your situation better.
As Eric Barker writes, “If you can do one little thing to make it a little bit better, then do that. If you can do another thing and then another thing, and then you can have cascading positivity as opposed to spiraling negativity.” Ask yourself, “What is my next step to make this situation just slightly better?” Consider some of the planning ideas and strategies outlined here for your next step.-Chris Benson, CPA, PFS
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.
Please see Additional Disclosures more information.