COVID-19 (1 of 3): A Comparison to Prior Pandemics and a Comment on Uncertainty

Good afternoon,

I hope everyone is enjoying the weekend.  As you may know, this was a rough week for global equities.  I wanted to send out this review as I have received some calls and emails about the week.  The S&P 500 was down 11.3% for the week and is now down 8.0% for the year.  The scare affected all sectors, but the energy sector (i.e. Exxon, Chevron, Kinder Morgan) was down the most at a loss of 16.4%.  The communications services sector (i.e. Facebook, Google, Netflix) was down the least at a loss of 9.6%.  Here is a summary of how the 12 asset categories I track performed this week:

As you can see the higher risk categories were down significantly, and lower risk categories improved for the week as some investors moved to safer havens.  This does NOT mean those who moved made the right choice.  They likely moved after they felt some impact, selling low and likely incurring some tax impact on the way.

Those of you that are in or close to retirement felt less of an impact compared to those who are farther away from retirement.  We do not change allocations because of fear.  We change them methodically as we approach our goal.  One of my main responsibilities is to be a barrier between you and a bad decision.

Since this week was primarily linked to COVID-19, I thought it would be useful to compare to other outbreaks.  The big scare seems to be uncertainty in the fatality rate (estimated at 1.0%) and uncertainty in the contraction rate (i.e. how many people will contract the virus).  Neither of these rates will be known until after the fact.  Below is a comparison to some other major outbreaks.

How did the market perform during these other outbreaks?  Neither of the other three was as bad as COVID-19.  The worst was the Spanish Flu, in which the Dow was down 11% over the entire period.  It quickly shot up after the virus was contained.  (https://seekingalpha.com/article/133636-1918-spanish-flu-and-the-market).

I suspect the reason for no market reaction to the 2009 swine flu pandemic was contextual.  We were just coming off some great pains as a result of the Great Recession, and the market was already at a floor where people basically thought "who cares" or "what else could go wrong" in terms of their portfolios.  All market analysis needs to be performed with this sort of contextual background.  Simply saying we are near a recession because it has been so long since the last recession is a weak analysis and not fundamental.  Buying energy stocks because the price is low is not contextual, but I see many advisors over allocating that sector since the price drop back in 2014. A decision they certainly lament!  The current price is always our most accurate assessment of value.  Unless you have a reason, these easier methods of saying 'price is low' or 'the market is high' or 'it has been a long time' are not going to prove fruitful.  People have been asking me about the expansion ending since 2016.  If they had gotten out in 2016, then it would have proved a bad exit and they would have missed out on a lot of gains.  

The biggest issue facing the market right now are those question marks ????  in the table above (i.e. fatality rate and contraction rate).  In a nutshell, uncertainty.  As Seneca said, "We suffer more from imagination than from reality."  

Risk is always present when we invest.  It is the reason we get rewarded over the long term - for taking on risk.  Corrections should be viewed contextually.  All corrections are the result of a change in expectations.  Expectations for the economy, rumors of war, trade policy, etc.  All of these expectations are baked into prices today.  Today's prices are more efficient than ever before because of technological advances.  However, that means changes in expectations may be felt quicker.  A wider range of expectations (i.e. uncertainty) is also a change in expectations.

The question we must ask is whether we expect uncertainty regarding the coronavirus to increase or decrease in the future versus where it is today.  Furthermore, if we expect uncertainty to increase (which I do not), then we must ask at what point will certainty return.  The second question is even harder to get correct than the first.

It is akin to trying to time the market.  Even if you were correct and moved to a more conservative allocation last Friday the 21st, when would you get back in?  The majority of market moves happen when the market is closed.  Not only do you have to know when to get back in, but changing your allocation would also likely result in paying some taxes as a result of selling in taxable accounts. 

That being said, I am more than happy to discuss allocation changes with anyone after we have a call and come to a rational decision. 

The chart below shows that over the last 20 years, the average of the year-end returns of SPY (an ETF tracking the S&P 500 index) was positive +8.2%.   The low during the year averaged down -11.1% from the prior year-end.  For example, 2016 ended up 12.0% versus 2015.  However, at one point in 2016, it was down -11.2% versus 2015.  

In 10 out of the last 20 years, the S&P was down more than 10% at some point during the year.  However, it ended up being positive in 15 of those 20 years.  These are huge swings.  The average swing is 19.3%!

The best strategy remains our current one:

1)  Select an allocation based on your goal (time until goal starts and length of goal).

2)  Get more conservative as you approach that goal.

3)  In the meantime, become maximally EFFICIENT.  Lower your fees and taxes.

I am always available for a call at any time of the day, including weekends.  If you have any questions at all, please do not hesitate to give me a call.

Thank you,

Matt Schwegman, CFP®, CPA

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