As you know, market downturns and bouts of volatility aren’t rare events—even those that grow out of health crises such as the SARS (severe acute respiratory syndrome) outbreak in 2003 and the Zika virus outbreak in 2016. One key to getting through such turbulent times is to try and understand that these market conditions don’t last forever and that markets can recover more quickly than you might think. Remember that investing is long term, and takes into account that there might be some market bumps along the way.
Of course, there are no guarantees when it comes to the markets. A market rebound can take days, weeks, or even months. The new coronavirus has dealt a significant blow to the economy of China, an economic leader and an essential link in the global supply chain. Nonetheless, if your investment plan is sound, and you continue investing through corrections, you can find a way to stay on track to reach your long-term financial goals.
Here are 4 tools to help you along the way
Understanding market downturns
Gain a better understanding of the types of market declines and how to best respond to them.
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Smart things to do (that many won’t) in a down market
Understand the actions and attitudes that are under your control to weather market volatility.
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Short-term volatility: What’s your move?
Market reactions to previous health crises can offer useful lessons today.
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Beat the short-term market jitters?
Keep market swings in perspective by taking a long-term view.
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February 27, 2020
The world is watching with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.
At Dimensional, it is a fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.
Market declines can occur when investors are forced to reassess expectations for the future. The expansion of the outbreak is causing worry among governments, companies, and individuals about the impact on the global economy. Apple announced earlier this month that it expected revenue to take a hit from problems making and selling products in China1. Australia’s prime minister has said the virus will likely become a global pandemic2, and other officials there warned of a serious blow to the country’s economy3. Airlines are preparing for the toll it will take on travel4. And these are just a few examples of how the impact of the coronavirus is being assessed.
The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. Our investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.
We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire.
Dimensional also stands behind the important role financial professionals play in helping investors develop a long-term plan they can stick with in a variety of conditions. Financial professionals are trained to consider a wide range of possible outcomes, both good and bad, when helping an investor establish an asset allocation and plan. Those preparations include the possibility, even the inevitability, of a downturn. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.
1Apple, February 17 press release. https://www.apple.com/newsroom/2020/02/investor-update-on-quarterly-guidance/
2Ben Doherty and Katharine Murphy, “Australia Declares Coronavirus Will Become a Pandemic as It Extends China Travel Ban,” The Guardian, February 27, 2020. https://www.theguardian.com/world/2020/feb/27/australia-declares-coronavirus-will-become-a-pandemic-as-it-extends-china-travel-ban
3Ben Butler, “Coronavirus Threatens Australian Economy Reeling from Drought and Fires,” The Guardian, February 5, 2020. https://www.theguardian.com/business/2020/feb/05/coronavirus-threatens-australian-economy-reeling-from-drought-and-fires; Ed Johnson, “Australia Says Economy to Take ‘Significant’ Hit from Virus,” Bloomberg, February 5, 2020. https://www.bloomberg.com/news/articles/2020-02-05/australia-says-economy-to-take-significant-hit-from-virus
4Alistair MacDonald and William Boston, “Global Airlines Brace for Coronavirus Impact,” The Wall Street Journal, February 26, 2020. https://www.wsj.com/articles/germanys-lufthansa-makes-cuts-as-it-braces-for-coronavirus-impact-11582712819
Sit tight or time to react? The evidence is clear.
As of March 2, 2020, there are ~90,000 confirmed cases and ~3100 reported deaths (see map). The equity markets have “corrected,” dropping more than 10% last week alone. News channels are on a 24 hour cycle, showing average people panicking, stocking up on basic household and food items. It’s understandable that you may be wondering what to do in these times as well. It may be difficult to stay rational when we still don’t know how much the COVID-19 will disrupt our lives and for how long.
The Markets Are Working As Intended
At least when it comes to your investments, there is nothing to indicate that the markets have broken down. Right now, like they do daily, market participants are reacting to the news and latest information. Participants are driving all available news, information, and expectation into prices. When the outcome is still unknown, millions of participants can’t all agree, increasing the market volatility. This is normal. And it’s normal if this uncertainty gave you a bit of anxiety, as well.
Here’s What You Should Be Doing
Allowing emotions or opinions about short-term market conditions to impact your investment plan can lead to disappointing results. This is precisely the wrong time to react. For example, when a blizzard hits, the people who already own snow tires are usually happier than those venturing out into the cold. In the same way, it’s generally best to make decisions rationally during periods of low market volatility, rather than emotionally during market dips and swings.
We’re in the middle of a storm right now. When it comes to investing, it’s the long term climate that you should be focusing on, not on the short-term weather.
Of course, this is easier said than done. Our behavioral biases are counterproductive when it comes to investing; we tend to be our own worst enemy. However, if we look back at similar cases, the data show that markets always recover:
Hopefully this puts your mind at ease a bit. Your best bet is to stay in your seat, to remain disciplined with a globally diversified portfolio of low-management fee index funds or etfs.
For the first time the Global Risks Report is dominated by the environment.
From World Economic Forum (weforum.org): Following a year of floods and droughts, when fires ravaged Australia and the Amazon, and teenage climate activist Greta Thunberg was chosen as Time’s Person of the Year, it is perhaps little wonder that environmental issues dominate leaders’ concerns for the future.
But the latest edition of the World Economic Forum’s Global Risks Report shows how loudly they are sounding the alarm. Established leaders and up-and-comers agree: climate change is the stand-out long-term risk the world faces.
The report, which identifies the top threats facing our world by likelihood and extent of impact, names failure to mitigate and adapt to climate change as the key concern for the Forum’s network of business leaders, NGOs, academics and others. The group places it as the number one risk by impact and number two by likelihood over the next 10 years.
In fact, respondents to the Global Risks Perception Survey, which underpins the report, rank issues related to global warming – such as extreme weather and biodiversity loss – as the top five risks in terms of likelihood over the coming decade. This is the first time one category has occupied all of the top slots since the report was launched in 2006.
Image: World Economic Forum Global Risks Perception Survey
Climate change is hitting harder and accelerating faster than many people predicted. And efforts to meet commitments to limit global warming are slipping, with countries veering off course. For the Global Shapers Community – the Forum’s younger constituents – environmental issues are even more pressing and top their list of concerns both in the short and long term.
Image: World Economic Forum Global Risks Perception Survey
Doing Well by Doing Good
As citizens, individuals can initiate positive change by expressing their political preferences around sustainability through the ballot box. As investors, they can express their preferences through participation in global capital markets. Indeed, a strong case can be made that the latter can have a larger and more immediate impact. And it certainly doesn’t mean having to compromise returns.
Investors can evaluate those companies being considered for investment using a focused set of environmental issues that reflect their primary concerns. For example, if one is trying to reduce a portfolio’s greenhouse gas emissions and potential emissions from fossil fuel reserves, the worst offenders across all industries may first be deemphasized or excluded from the portfolio altogether. An across-industry comparison of this nature provides an efficient way to significantly reduce the aggregate greenhouse gas emissions per unit of revenue produced by companies within a portfolio with a minimal reduction in diversification.
Then, companies may also be rated on sustainability considerations. For example, this could include retail companies that improve the energy efficiency of their facilities, utilities that produce electricity using solar or wind power, trucking companies that improve the fuel efficiency of their fleets or use alternative-fuel vehicles, or energy companies that increase efficiency, reduce waste, and improve their overall environmental footprint. On the other hand, companies with poor environmental sustainability ratings relative to industry peers may receive a lesser weight or may be excluded.
Investing well and incorporating values around sustainability need not be mutually exclusive. Starting with a robust investment framework, then overlaying the considerations that represent the views of sustainability-minded investors allows for a cost-effective approach that provides investors the ability to pursue their sustainability goals without compromising on sound investment principles or accepting lower expected returns. By aligning our values with investment goals, each of us can make a positive and an immediate difference.
You can read more about our sustainability portfolios here.