As this article went to print, the S&P 500 had declined 13% from its all-time high on February 19th. Market corrections are a natural and healthy part of the market cycle, and present good buying opportunities—that is, of course, until you find yourself in the throes of one and just want out! Anyone in the investment industry for any significant period of time has endured many a correction, and it’s at times like these that a few movie clips start to circulate among numb front-line investors in an effort to lighten the mood. One in particular is the “Panic Attack” scene from Airplane, in which a passenger having a panic attack is shaken violently by an assorted lineup of characters, including a stewardess, a doctor, and a nun, and told to “Calm down!” “Get ahold of yourself!” and “Everything is going to be all right!” Now for those readers who have more evolved movie tastes than yours truly and have not seen Airplane, I would encourage you to view the clip online and think of the passenger as an investor and the lineup of ham-handed consolers as experts urging calmness and composure (with a healthy dose of satire) in the face of the latest move down in stock prices.
The experts are saying, “Don’t panic,” and they’re right. Let’s separate the definition of “correction” into two parts. The first component is simple and is the most often cited metric by which a correction is measured, and that is when a market index falls 10% or more from a recent peak. Another component, often overlooked, is that corrections in many cases follow brief surges in market prices. The S&P 500 gained 9.1% in last year’s fourth quarter! That’s a remarkable quarter, especially in the context of where we are in the economic cycle. The US economy is in the 11th year of an economic expansion—a record long streak. The S&P 500 is now back at levels seen in October 2019. It’s been a painful descent to be sure, but the clock has only been turned back to last fall.
Every correction has its villains. Some are more easily identified than others. The current one is largely blamed on a very sad situation originating in China but now spreading globally: coronavirus or COVID-19. Efforts to contain the spread of the virus are having dramatically negative impacts on global economic activity. It’s too early to know the magnitude and duration of the hit to economic statistics and corporate earnings, but it will be significant.
Can the correction be blamed entirely on the devastating impact of coronavirus? There’s no clear-cut answer to that question. But if we were to draw upon our studies of investor psychology, we might say that when market prices have prolonged or sharp advances, like that just witnessed in the fourth quarter of last year, there seems to be an inclination to look for excuses to take some chips off the table and lock in those gains. In other words, a correction was overdue. Selling begets selling, and a precipitous decline in stock prices ensues.
This takes us back to the beginning: Corrections are natural and healthy. During turbulent stretches in the markets, we are especially fortunate that a great distance separates us from the financial capitals of the world like New York, London, and Hong Kong. Having spent a portion of my early career in New York City, I experienced firsthand how group think can lead to fear breeding more fear. Cooler heads did not always prevail in that environment. Being overly reactionary is not a good investment practice.
As always, please feel free contact our team if you have any particular questions or concerns.
Anthony Smith, CFA
Q. How far has the market declined?
A. As of the end of day, February 28, 2020, major global stock market indices have fallen sharply since February 19th, while short-term bond funds have provided stability.
Q. What are you doing with client portfolios during this decline?
A. When markets decline or increase significantly, a portfolio becomes out of balance. For example, if the market falls 10%, and an investor was 50% stocks and 50% bonds prior to the decline, the portfolio will be 55% bonds and 45% stocks after the decline. Thus, the prudent strategy is to buy low and sell high by selling 5% of the over allocation to bonds (selling high) and purchasing 5% stocks (buying low). In summary, HFG Trust is making trades to rebalance client accounts where needed.
Q. What are you seeing that is appetizing?
A. To answer that question we need to examine the available investment options. In the world of investments, markets can be divided into bonds (preservation of capital and income) and stocks (long-term appreciation and growing income). Since the beginning of the year, rates on shorter-term bonds have fallen from 1.75% to 1.40%. Long-term, 30-year US Government yields are well below 2% today, the lowest in history. When one examines the relative attractiveness of bonds at 1-2% versus a portfolio of global dividend stocks, I believe the contrast is striking. The yield on the US High Yield Stock Dividend Index and the Global High Yield Dividend Index is 3.5%-4%, while the S&P 500 yield is closer to 2%. Yield is the income an investment generates; and historically, dividends have increased at a rate faster than inflation. For example, the cash dividend on the S&P 500 in 2000 was $15.82 and increased to $58.69 in 2019, representing an annual growth rate of approximately 7%, as Exhibit I illustrates below. If an investor has a time horizon beyond 5-10 years, global dividend stocks represent a compelling alternative to bonds. What makes global stocks risky is the near-term uncertainty of price. Should you buy today, or will prices fall further? This is the age-old dilemma. However, if one is asking, “Where am I likely to get return over the next decade?” the picture becomes more clear.