This month, we look back at 2020 to discuss three of the most crucial lessons we learned and how they may help in light of recent market volatility.
As of the end of August, US Stocks (as measured by the Russell 3000 Index) had continued their remarkable climb – up over 20% for the year. Outside of January, every other month this year has brought about positive US stock returns. That trend is set to reverse in September as volatility has gripped the market with concerns over economic growth slowing, the continuing spread of the Delta variant of the coronavirus, and the potential that the Fed will dial back its support of the financial markets. Abroad, recent worries over Chinese property developer Evergrande’s ability to pay off interest on its considerable debt have contributed to global stock market declines. With uncertainty and market volatility taking center stage again, we thought it would be a good opportunity to look back on some important lessons that we learned during the height of the pandemic last year.
Rebalancing Policies – Remove Emotion From Investing
The first, and arguably most crucial, lesson we learned from the events of 2020 was the importance of following a disciplined investment approach in order to reliably pursue long-term investment goals. When markets dip, it becomes difficult to separate emotions from investing. After a 10-year long bull market and the incredible rebound from the effects of the COVID-19 pandemic, even a small drop in equity markets can feel jarring. Having prudent and robust investment policies outlining both target asset allocations and allowable drift from those targets enables our clients to readily identify when policies dictate to make trades to rebalance their portfolios. We realize it’s impossible to know exactly when the right time will be to rebalance, but we firmly believe having specific rebalancing thresholds that dictate when to buy into what’s relatively low and sell from what’s relatively high will benefit you in the long term.
Markets Are Efficient and Process Information Quickly
2020 was also a lesson in how markets continually incorporate new information and changes in expectations. Beginning in February of last year, the S&P 500 Index fell over 33% in less than five weeks as news headlines suggested more extreme outcomes from the pandemic. But the recovery would be swift as well. Market participants were watching for news that would provide insights into the pandemic and the economy, such as daily infection and mortality rates, effective therapeutic treatments, and a fiscal response from the US government.. As more information became available, the S&P 500 Index jumped more than 17% in just three trading sessions, one of the fastest snapbacks on record. This period highlighted the vital role of data in setting market expectations and underscored how quickly prices adjust to new information.
The Benefits of Diversification
The coronavirus pandemic underscored the importance of remaining broadly diversified across business sectors and industries. The downturn in stocks impacted some segments of the market more than others in ways that were consistent with the impact of the COVID-19 pandemic on certain types of businesses or industries. For example, airline, hospitality, and retail industries tended to suffer disproportionately with people around the world staying at home, whereas companies in communications, online shopping, and technology emerged as relative winners during the crisis. However, predicting at the beginning of 2020 exactly how this might play out would likely have proved challenging.
As we face new and evolving challenges, the market will continue to function by reflecting those new and evolving changes in real time, which means greater volatility. In light of those new developments, we recommend looking to your policies to instill discipline when making buy and sell decisions, understand that the market will price in new information in real time, and remain invested broadly across asset classes as different market segments and countries react differently to risks.