9 Key Reminders For The Recent Market Turmoil

Stocks around the world have been incredibly volatile in recent weeks because of the new coronavirus, COVID-19. All over the world, business activity has slowed, large-scale gatherings of people have been cancelled, planes are grounded, hotels are empty, people are quarantined, and healthcare systems are pushed to their limits. Recessionary fears are also rampant.

Amidst the market and societal turmoil, I want to share some important investing-related reminders for all of us to provide context, soothe fraying nerves, and be a voice of calm, reason, and peace.

But before I get there, I want to stress this: COVID-19 or no COVID-19, recession or no recession, I am not changing the way I am investing. Regardless of how COVID-19 or the global economy develops, the stock market is still a place to buy and sell pieces of a business. This also means that a stock will do well eventually if its business does well. So I will continue looking for companies that excel according to my investing framework, and investing in their shares for the long run.

On to the update…!

1. Recessions are normal

The chart below shows all the recessions (the dark grey bars) in the US since 1871. You can see that recessions in the country – from whatever causes – have been regular occurrences even in relatively modern times. They are par for the course, even for a mighty economy like the US.

The following logarithmic chart shows the performance of the S&P 500 (including dividends) from January 1871 to February 2020. It turns out that US stocks have done exceedingly well over the past 149 years (up 46,459,412% in total including dividends, or 9.2% per year) despite the US economy encountering numerous recessions. If you’re investing for the long run, recessions can hurt over the short-term, but they’re nothing to fear.

2. The stock market has regularly seen serious short-term losses while on its way to earning great long-term returns

Between 1928 and 2013, the S&P 500 had, on average, fallen by 10% once every 11 months; 20% every two years; 30% every decade; and 50% two to three times per century. So stocks have declined regularly. But over the same period, the S&P 500 also climbed by 283,282% in all (including dividends), or 9.8% per year. Volatility in stocks is a feature, not a bug.

In fact, stocks have also experienced brutal one-day drops that – with the proper perspective – turn out to be blips.

Some market commentators have labelled 9 March 2020 as Black Monday because the S&P 500 fell by 7.6% that day. But that is nothing compared to the historical Black Monday – on 19 October 1987, the S&P 500 plunged by 20.5%. To make matters worse, the index was already down by 10.1% in the three days preceding 19 October 1987. So in four trading days – from the close on 13 October 1987 to 19 October 1987 – US stocks were down by 28.5% in all.

Black Monday (the historical one) was a harrowing experience for those who lived through it. But here’s the thing: From 13 October 1987 (before Black Monday happened) to 9 March 2020, the S&P 500 was up by 773% in total, or 6.9% per year. With dividends, the S&P 500 was up by around 2,100%, or 10.0% annually.

From an individual stock perspective, we can also look at the US e-commerce giant Amazon (NASDAQ: AMZN). The company (which is in my family’s investment portfolio) was a massive long-term winner from 1997 to 2018, with its share price rising by more than 76,000% from US$1.96 to US$1,501.97. But in the same timeframe, Amazon’s share price also experienced a double-digit top-to-bottom fall in every single year (the declines ranged from 13% to 83%).

One of my favourite finance writers is Morgan Housel. In an April 2019 blog post, he brilliantly articulated a concept that I’ve held in my mind for a long time: Instead of seeing short-term volatility in the stock market as a fine, think of it as a fee for something worthwhile. The stock market has produced good to great returns over the long-term. But it demands an admission fee. And the admission fee is what we’re currently experiencing.

3. Recessions and market crashes are inevitable

The late Hyman Minsky was an obscure economist when he was alive. But his ideas flourished after the Great Financial Crisis of 2007-09.

That’s because he had a framework for understanding why markets and economies go through inevitable boom-bust cycles. According to Minsky’s then radical view, stability itself is destabilising. When an economy is stable and growing, people feel safe. And when people feel safe, they take on more risk, such as borrowing more. This leads to the system becoming fragile.

The same goes for stocks. Let’s assume that stocks are guaranteed to grow by 9% per year. The only logical result would be that people would keep paying up for stocks, till the point that stocks become way too expensive to return 9% a year. Or people will take on too much risk, such as taking on debt to buy stocks.

But bad things happen in the real world and they happen often. And when stocks are priced for perfection, bad news will lead to lower stock prices.

4. There is always something to worry about

Peter Lynch, the legendary manager of the Fidelity Magellan Fund from 1977 to 1990, once said that “there is always something to worry about.” How true. The table below, constructed partially from Morgan Housel’s data, shows that the world had experienced multiple crises in every single year from 1990 to 2019.

But over the same period, US stocks were still up by nearly 800% after factoring in dividends and inflation.

COVID-19 is not the first deadly disease outbreak the world has faced. But global stocks have registered solid long-term gains despite multiple occurrences of epidemics/pandemics in the past. The chart below shows the performance of the MSCI World Index (a benchmark for global stocks) from 1970 to January 2020 against the backdrop of the various epidemics/pandemics we’ve experienced in the past 50 years.

5. Don’t invest in stocks with money that you will need within five years, at least; also, don’t use leverage

When I was helping to run the Motley Fool Singapore’s investment newsletters, my ex-colleagues and I repeated the same message over and over again: You should not invest with money that you need within the next five years.

The message is meant to prepare for days like we’ve seen over the past few weeks. The worst thing that can happen to us as investors is to be placed in a position where we’re forced to sell stocks. It doesn’t matter if we’re forced to sell when stock prices are high. But it can be disastrous to be forced to sell when stock prices are low.

To reap the rewards of long-term investing, we need to give ourselves holding power. And a very simple but effective thing we can do to gain holding power is to invest with money that we would very likely not need to touch for a good number of years.

Another simple but effective way we can have holding power in the financial markets is to not use leverage. Investing with leverage is to invest with borrowed capital. If we invest with leverage, we could very easily become forced-sellers when stocks fall. This becomes a severe headache during occasions when stocks fall sharply, such as over the past few weeks. 

6. Volatility clusters

As mentioned earlier, the S&P 500 fell by 7.6% on 9 March 2020. The decline was so severe it triggered a circuit breaker in the process. On 10 March 2020, the prominent US market benchmark jumped 4.9%. A great day in the market followed a bad day.

This clustering of volatility is actually common. Investor Ben Carlson produced the table below recently (before March 2020) which illustrates the phenomenon.

The clustering means that it’s practically impossible to side-step the bad days in stocks and capture only the good days. This is important information for us, because missing just a handful of the market’s best days will destroy our returns.

Dimensional Fund Advisors, which manages more than US$600 billion, shared the following stats in a recent article:

• $1,000 invested in US stocks in 1970 would become $138,908 by August 2019
• Miss just the 25 best days in the market, and the $1,000 would grow to just $32,763

So it is important that we stay invested. But this does not mean we should stay invested blindly. Companies that currently are heavily in debt, and/or have shaky cash flows and weak revenue streams are likely to run into severe problems if there’s an economic downturn. If a global recession really happens this time (it looks increasingly likely that it will) and our portfolios are full of such companies, we may never recover. It’s good practice to constantly evaluate the companies in our portfolios, but I think there’s even more urgency to do so now.

7. Stick with high-quality businesses – don’t be attracted to a stock just because it has a low valuation

It’s easy for us to be lured by stocks that have low valuations after sharp declines in their prices. But it’s crucial that we also pay attention to the quality of the underlying businesses of the stocks we’re looking at. Low-quality businesses can’t compound in value. If we invest in them, our investments can’t grow over time. We may even lose money.

My friend Chin Hui Leong is a whip-smart investor and the co-founder of The Smart Investor, an investment education website. On 5 May 2009, he invested in American Oriental Bioengineering (AOB), a China-based pharmaceuticals company that was listed in the US. Chin was attracted to its low valuation – back then, AOB’s price-to-earnings ratio was only 7.

The S&P 500 reached a bottom during the Great Financial Crisis in March 2009 (it hit 677 points) and has nearly quadrupled since. So the timing of Chin’s investment in AOB was great. But he went on to effectively lose his entire investment in the company over a few short years because of its poor business performance subsequently. From 2009 to 2013, AOB’s revenue shrank from US$296 million to US$122 million while its US$41 million in profit became a loss of US$91 million. A cheap stock can easily become a big loser if its business does poorly.

Chin also has a fantastic and inspiring example of what can happen if we stick with high-quality businesses. He invested in Netflix (NASDAQ: NFLX) (my family also owns shares of Netflix) on 12 January 2007 at a share price of around US$3.20. On this occasion, his timing was poor. The S&P 500 closed at 1,431 on the day of his Netflix investment and reached a peak of 1,565 on 9 October 2007 before the Great Financial Crisis hit. But today, Netflix’s share price is around US$330, about 100 times higher than when he first invested. 

8. Oil prices are low now, but we still shouldn’t buy oil & gas stocks indiscriminately

There are two widely-tracked prices for oil: West Texas Intermediate (WTI) crude and the international benchmark. Brent crude. Both shockingly fell by more than 30% each on 9 March 2020 at their respective low points.

WTI eventually closed the day with a 24.6% decline to US$31.13 per barrel while Brent crude settled with a 24.1% slide to US$34.36 per barrel. These prices were the lowest seen since February 2016. Some market observers have linked this sharp fall in oil prices to the recent turmoil in financial markets that we are seeing.

The lower oil prices have also caused the share prices of oil & gas stocks around the world to plummet. In the US market, Exxon Mobil (NYSE: XOM) plunged by 12.2% on 9 March 2020. Meanwhile, at our home in Singapore, Keppel Corporation (SGX: BN4) fell by 9.6% while Sembcorp Marine (SGX: S51) was down by 11.4%.

Oil prices are near multi-year lows now – they were around US$100 in 2014 and around US$32 at the moment. It could thus be tempting to pick up oil & gas stocks with the view that their share prices will tag along when oil prices rise. There are two problems here.

First, it’s practically impossible to forecast future oil prices. In 2007, Peter Davies gave a presentation titled What’s the Value of an Energy Economist? In it, he said that “we cannot forecast oil prices with any degree of accuracy over any period whether short or long.” Back then, Davies was the chief economist of British Petroleum, one of the largest oil & gas companies in the world.

Second, oil prices and oil & gas stocks can move in opposite directions. In mid-2014, oil prices started their rapid descent from around US$100. WTI reached a low of US$26.61 in February 2016. 10 months later (on 21 December 2016), WTI had doubled to US$53.53. But over the same period, 34 out of a group of 50 Singapore-listed oil & gas stocks saw their share prices fall. The average decline for the 50 companies was 11.9%.

There can be many obstacles that stand between a positive macrotrend and higher stock prices. In the case of oil & gas stocks, these include a weak balance sheet and deteriorating business fundamentals as a result of poor operational capabilities.

9. We will get through this 

There are 7.8 billion individuals in our globe today, and the vast majority of us will wake up every morning wanting to improve the world and our own lot in life – COVID-19 or no COVID-19. This motivation is ultimately what fuels the global economy and financial markets.

Miscreants and Mother Nature will occasionally wreak havoc. But we should have faith in the collective positivity of humankind. We should have faith in us. We can clean up the mess. To me, investing in stocks is the same as having faith in the long-term positivity of mankind. I continue and will continue to have this faith, so I continue and will continue to invest in stocks.

I want to leave the last words in this article to Morgan Housel. A few days ago he published a blog post with the most apt of titles: We’ll Get Through This. In it, he wrote:

“Remember that when progress is measured generationally, results and performance should not be measured quarterly.

It looks bad today.

It might look bad tomorrow.

But hang in there.

We’ll get through this.” 

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.