COVID-19 Update No.5
Volatility and Market Returns
Last week, the US stockmarket had its strongest three-day percentage increase since 1931[i]. With COVID-19 infections still growing amongst the global community, how is this possible?
It’s a fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. Financial markets are always forward looking and in this case, they factored in large scale support from governments and central banks. The US jobless claims also were better than the market expected, but still high at 3.28 million people. Markets don’t react to what is happening today, they react to new information and consensus expectations for the future. So, it’s important to note that as the number of infections and (sadly) deaths relating to COVID-19 grows, at the same time markets could still trend upwards. This is not to suggest the market has bottomed yet.
We’ve shown in recent articles that markets have always rebounded from significant falls, but the timelines for market recoveries do differ.
The graphic below considers every 10%, 15% and 20% market decline in the US since 1926, and the average annualised return in the following 1, 3 and 5 years.
Source: Fama/French Total US Market Research Index Returns, July 1926 to December 2019
You can see that for market declines of 20% or more, which we are currently experiencing, the market has historically delivered strong average annual returns of 11.76% for the next 5 years.
The next graph looks at the 1, 3- and 5-year returns (in absolute rather than annualised terms) following the most recent significant global events to negatively impact global stockmarkets[ii]:
Taken together, these graphs demonstrate that market returns following significant falls are normally above long-term averages.
The mindset of getting out of the market “just until the worst is over” is a dangerous move for long-term investors. First, market timing in general is a loser’s game. It’s nearly impossible to predict when to jump out so you miss all the worst days without missing the good days, too.
Second, missing even a few of those very good days could make a huge impact on long-term returns. The Vanguard chart below shows the average return of the S&P 500 between 2000 and 2017. If you’ll remember, the S&P 500 had some really bad days during these decades.
But if you stick to your plan and stay invested for the long term and experience all the days in the market, including the nasty ones, you still show a decent return over this period:
Source: Vanguard
If you’re a long-term investor, you are in a fortunate position because you can invest in markets without the worry and anxiety of needing to know what is going to happen tomorrow. Markets are uncertain, but if you focus on decades rather than days, weeks or months, you can reasonably expect to receive a good return.
If markets weren’t uncertain, we’d call them a savings account, and the returns would be very different, i.e. much, much lower.
Author: Rick Walker
[i] https://www.smh.com.au/business/markets/5-trillion-fightback-wall-street-rallies-again-setting-up-asx-for-more-gains-20200327-p54edm.html
[ii] Source: Dimensional. In AUD. Balanced Strategy: 30% S&P/ASX 300 Index (total return), 30% MSCI World ex Australia Index (AUD, net div.), 20% Bloomberg AusBond Bank Bill Index and 20% FTSE World Government Bond Index 1-3 Years (hedged to AUD); rebalanced semiannual. S&P/ASX data copyright 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. MSCI data copyright MSCI 2020, all rights reserved. Data provided by Bloomberg. FTSE fixed income indices © 2020 FTSE Fixed Income LLC. All rights reserved. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. Returns of model portfolios are based on back-tested model allocation mixes designed with the benefit of hindsight and do not represent actual investment performance. Returns taken one month after specified crisis date.