“Fear incites human action far more urgently than does the impressive weight of historical evidence.”
-Jeremy Siegel, Professor of Finance at the Wharton School of the University of Pennsylvania
Everyone here at The Nalls Sherbakoff Group, LLC, has our clients in our thoughts and prayers as we all deal with the COVID-19 pandemic. I know we’re all doing our best to arrest the exponential growth in the number of confirmed cases. The social distancing and “safer-at-home” initiatives no doubt will affect the overall U.S. economy and, indeed, might lead to the largest number of unemployed people ever. Thus, we are faced with both personal health risks and economic risks, as we try to deal emotionally with a lot of uncertainty.
If it’s one thing the market hates, it is uncertainty. On February 19, 2020, the market set both a new intraday high of 3,393.52, and a new closing high at 3,386.15. Then, in market lightspeed, the S&P 500 dropped to close at 2,237.40 on March 23, only 23 trading days later. That is a closing market drop of 33.9%, the fastest +30% drop in the history of the market.
Let’s look at a simple mathematical fact relating to percentages. If an investor puts $100 in the market and gets a return of -10%, she’ll have to have a return of 11.11% just to get back to even. Look at the chart below.
In this example, she has an average annual return of 0%, yet is down 1%; or she has an average annual return of 0.5% and just breaks even.
If an investor lost 20%, she would need a return of 25% to recover her original amount. Losing 50% requires a 100% gain – a doubling – to recover to her original amount. After a drop in the market, you need a higher percentage gain (because of less principal) to claw your way back to the original amount.
So, when we apply the “law of percentages” to the current down market, what does that tell us? At the end of March, the S&P 500 closed at 2,584.59. That is down 23.7% from the February 19 high. So, for the market to reach its all-time closing high of 3,386.15 from the March 31 value, 2,584.59, it needs to rise 801.56 points or 31.0%. Further, if investors are taking advantage of buying into the market at current values, then they have an expected return of 31% over some time frame to get back to the all-time high again.
If an investor thinks the market will recover in one year, then her annual expected return in 31%. What if she is confident that over the next two years the market will be at the record high again? That’s an annual average return of 14.46%. That’s not a bad return and it’s well above the long-term average annual return rate. Also, the two year average rate of 14.46% is almost exactly what the last bull market returned from March 2009 to February 2020.
Looking back over the history of bear markets, we find 13 bear markets since September 1929. This includes the one we are in now, going on month 2. The longest bear market in history was from March 1937 to April 1942, 61 months. The average bear market has been 22 months. Historically, bear markets have bottomed out around 22 months and started a new bull market, which have historically lasted 54 months.
However, we cannot know which way the equity market’s next 25% move will go, because the short to intermediate term outcomes are not merely unknown, but unknowable.
But, the bottom line is this. If you have confidence and faith that the U. S., and the world, will power through this pandemic by people staying home and following the suggestions and guidelines of our leadership, if you believe in capitalism as the driving force of creating wealth and financial freedom, if you can recognize and acknowledge the emotions and biases that cause you to worry over the markets, yet don’t make rash decisions based on that misplaced worry, then riding out this historic decline is how investors will earn the premium returns of equities when the firestorm of terror burns itself out and the permanent advance resumes.
Faith, patience, and discipline. This too shall pass.