First a disclaimer. The impact of the coronavirus on the stock market is not the first-order important story. The effect of the epidemic on lives, health, and social welfare is THE story. But we are an investment firm, and our clients have reasonable questions about what this means to them and their investment in capital markets.
We consider ourselves at Savant to have a lot of humility about our ability to forecast – while we make some predictions, we recognize that for the most part, forecasting the equity market involves predicting the unpredictable. The epidemic is a great example. At the beginning of the year, if we polled the ten most accomplished economists and asked each of them for the ten things that might adversely impact the stock market this year, none of them would have listed a global epidemic. And yet, for the past month, it has been the dominant factor affecting returns.
With the earlier disclaimer in mind, the question most of you want to know, and the question we cannot answer, is what will be the economic and capital market impact going forward. In the past, we have not shied away from stating that some market movements were overreactions – the Greek debt crisis of 2011, the Chinese growth fears of 2015, and the Brexit vote of 2016 all triggered stock price declines that we stated at the time were likely overreactions. In this case, we can’t make such a statement. Until the medical issues are better known, no one can possibly predict the resulting fair value of the world capital market.
What we can say is this – whether short-term reactions are warranted or not, the stock market tends to recover well from crises. The stock market has fallen 6% over the past two days. There have been 20 instances in the past 20 years in which the value of the S&P 500 has fallen by at least 6% in a month. The average annual return in the five years after the large declines is 12.1%, which is startling because the overall average annual return is only 5.8% over that same period. Indeed, in none of those post crisis five-year periods did the S&P 500 lose money – the lowest return was 0.5%, and the highest was 23.0%.
A less statistical and more intuitive analysis would be that even if the epidemic gets worse, nearly all the global economic impact will be short term. While short-term impacts are important, the factors that fuel equity valuations tend to be long term.
So, what does all this mean? Most of our clients are investing for long-term goals. While 2020 returns will certainly be impacted, we see no reason to change a long-term investing strategy because of the epidemic. No one can dispute that millions of people are impacted by coronavirus. But as investors, we must divorce the emotional reaction to the human crisis from the investment policy analysis.