As of this writing, the S&P 500 will have dropped close to 30% in less than 20 trading days. The decline is the fastest drop into bear market territory ever. The degree of health related and economic damage for businesses, profits and employment, a result from fallout of the coronavirus, remains so unknown that stocks in general are getting significantly hit and some industries, like airlines, cruise liners and entertainment concerns, are getting demolished. It goes without saying, but when stocks are in decline this, investors are discounting significant declines in profitability and perhaps survivability for some companies.
While no one has the answers to how deep this downturn will be and how far stocks will fall, there have been other market crises in the past. And while each one has its own causes and amount of damage they inflict, investors like Warren Buffett, Peter Lynch and lessons from market history can help guide us and give us confidence that over time, over the long-term, we’ll recover. Leaning on the wisdom of these great investors, particularly during times such as these, can help give us the conviction to make it through. So I thought it would be worthwhile to use this article to share some of that wisdom in what is a very uncertain and emotional time for many.
Buying Stocks in the Depths of the Financial Crisis
In the Fall of 2008, the U.S. and global markets were in rapid decline and the financial system and some of the world’s largest banks were on the brink of failure. The S&P 500 had fallen 30% from the period of May through early October and home prices across the U.S were seeing massive declines in value. This is right when Warren Buffett, in the middle of all the fear, stepped up and wrote an Op-Ed piece for the New York Times titled, “Buy American. I Am.” In it, he defended investing in American businesses over the long-term, explained we have seen other crisis’s and come back, and hit on the importance of investor temperament and long-term thinking during difficult economic times.
A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.
You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.
On October 16th, 2008, which is the day Buffett’s op-ed was published, the S&P 500 Index was at 946. Today, it stands at 2450. While that was a very different type of crisis, one driven by leverage and a bubble in real estate, that was the second worst decline in stocks and we saw a deep global recession. The economy and market recovered over time.
Markets Recover – A Timeless Lesson from Lynch
In 2001, Peter Lynch wrote a memo to Fidelity for investors right after the 9/11 tragedy, which was a very sad and difficult period for our country and economy. You can read the commentary here: Peter Lynch Market Commentary – Fidelity 9/20/2001. I won’t rehash all his points, but the table below helps summarize one of the main lessons he drives home. That is, we have been through many different crises as a country, and while this one certainly has the potential to have deep effects on the economy that are inestimable at this point, we also should understand that over time the economy and the markets recover from these types of exogenous economic shocks, as painful and scary as they may be at the time.
|Event||Event reaction dates||Percent of gain/loss during event||S&P 500 Performance 1 month later||S&P 500 Performance 1 year later||S&P 500 Performance5 years later||S&P 500 Performance 10 years later|
|Fall of France||5/9/40–6/22/40||-18.2||3.1||5.2||15.9||13.2|
|Attack on Pearl Harbor||12/6/41–12/10/41||-6.9||4.5||16||18.1||17.1|
|Outbreak of Korean War||6/23/50–7/13/50||-11.1||9.5||42||27.6||18.4|
|Eisenhower heart attack||9/23/55–9/26/55||-6.6||0.1||11.8||8.5||11.6|
|Cuban Missile Crisis||8/23/62–10/23/62||-9.9||15.5||41.1||15.8||11|
|U.S. attacks Cambodia||4/29/70–5/26/70||-15||6.4||49||9.3||9.3|
|1987 stock market crash||10/2/87–10/19/87||-31.5||7.1||27.9||17||18.9|
|Gulf War ultimatum||12/17/90–1/16/91||-2.8||17.2||36.6||17.3||18|
|Collapse of Long-Term Capital Management||8/28/98–9/9/98||-2||-2||35.8||1.8||3.7|
|September 11 terrorist attacks||9/10/01–9/21/01||-11.6||11.3||-11.1||8.3||3.9|
|U.S. invades Iraq||3/18/03–3/31/03||-2.1||8.2||35.1||11.3||8.5|
|Collapse of Lehman Brothers||9/5/08–11/20/08||-39.1||18.3||48.8||21.5||15.8|
|U.S. debt downgrade by S&P||8/5/11–10/3/11||-8||14.9||35||17||—|
Source: Putnam Investments: Markets recover from crises
Strong market returns after large declines is further backed-up by the analysis in a recent research note from Verdad. The firm looked at the performance of the S&P 500 12 and 24 months after a +20% and decline and measured the performance of stocks starting three months from hitting the down 20% level. The tables below show that returns are generally good for stocks following large declines in the market.
12M Returns Starting 3 Months from a 20% Drop in the S&P 500
24M Returns 3 Months from a 20% Drop in the S&P 500
Source: Verdad, “Making Good Decisions in Uncertain Times”
What Drives Long-Term Value?
For stock investors, it’s important to remember that most of the value of income producing assets and companies come from well into the future, not the here and now. In a recent podcast, Professor Jeremy Siegel, author of Stocks For the Long Run, reminded us that “more than 90% of the value of stocks is dependent on profits more than 12 months out into the future.” This doesn’t mean that stocks can’t disconnect a lot from their long-term fundamental value in the short term, when fear and uncertainty are extremely high, such as times like we are in right now. But over time, the value of companies is determined from cash flows multiple years out. This doesn’t make the pain being experienced by investors any easier today, but it should give you solace that once we get back to normal and the economy heals and recovers, the value of stocks will ultimately reflect the long-term earnings power of companies.
Do the Right Thing
During World War II, Winston Churchill said “You can always count on the Americans to do the right thing after they have tried everything else.” Over the next days, weeks and months, it looks very likely that we will be seeing significant monetary (i.e. Federal Reserve) and fiscal stimulus (i.e. taxes, loans to business and consumers from the government and stimulus efforts), as well as social distancing and the hunkering down of people across the country as a way to stymie the spread of the coronavirus and limit the long-term negative economic and market impact. Many of these policies will help, some of them may not, but ultimately the slowing of the coronavirus’s spread will be the first step in the recovery and once this happens, the market will likely discount the recovery and economic snapback. At that point, the words of Buffett and Lynch, and Churchill should then ring true once again.
Photo: Copyright: 123rf.com / lkeskinen