Exactly one year ago today, I published a blog post on what was then the novel, rapidly spreading coronavirus. Markets were in disarray. The world was in a state of shock and panic. There were runs on food and household items as everyone frantically prepared for what seemed like an extended lockdown the likes of which we had never experienced before. Our schools, places of worship, offices, and restaurants had closed or were on the verge of doing so. And yet despite common sense and all obvious signs to the contrary, I was hopeful. In my blog, I wrote that even with all the unknowns, I was still certain of a few things. Primarily, that the human race endures. We adjust, we problem solve, we adapt and we overcome. Reflecting back, twelve long months and three approved incredibly exciting vaccines later, I believe this is exactly what we have done.
While acknowledging that we are not out of the woods yet with COVID-19, I still believe that this is an opportune time to reflect on three lessons that we've learned about investing.
The stock market looks forward
As the markets rose last year in what seemed like defiance of the still rapidly spreading coronavirus, a common complaint of investors was that the markets and the economy seemed completely disconnected. This is an excellent reminder for us that the markets and the economy are just that - disconnected. The economy is not the stock market and the stock market is not the economy.
The stock market is forward looking. The markets price in what they expect to happen both in the short-term and in the longer-term. But the economy is generally a reading of what has already happened. For example, recessions (defined as two quarters of economic retraction) are only designated so after they have happened. Only after all the data has been collected and reported do we know that a recession has occurred. Same goes for GDP, the unemployment rate, consumer sentiment, manufacturing data, among others. These are all data points that are collected from time periods that happened in the past and are reported as 'current' economic data.
The stock market however is predictive. Investors that drive much of the markets' daily movements do not invest based on what has happened in the past, they invest based on what they expect to happen in the future. If investors expect the economy to go into recession next year, they will not wait until next year to sell shares. They will sell shares today in anticipation of the economic decline. And as we witnessed last year, if they expect economic activity to pick up robustly, then they will buy shares now in anticipation of the expected turnaround.
Lesson #1: The economy and the stock markets are not one in the same.
Often in investing, no reaction is the best reaction
When faced with a stressful situation, our natural knee-jerk reaction is to do something immediately. We try to do anything to help solve the problem. In many cases, that's the right thing to do. If the oven catches fire, we grab the fire extinguisher and put it out.
However, when it comes to investing, an emotional reaction can mean doing lasting damage to your wealth. When the market crashed in March 2020, it was tempting to do something you wouldn't normally consider, such as moving investments to cash. However, unlike in real life emergency situations, investing sometimes means doing nothing is the right thing to do.
If you are going to make changes to your investment allocation or to reexamine your risk tolerance, the time to do that is when markets (and you) are calm.
Lesson #2: Never make investment decisions driven by acute fear.
Panic creates opportunity
This time last year, Warren Buffett's words were especially applicable. Buffett tells us to "be fearful when others are greedy, and greedy when others are fearful." Panic can create opportunity. And these opportunities only avail themselves to those who manage to keep calm.
What was remarkable about last year's stock market was that the S&P 500 went from bull market to bear market and back to bull market between February and August 2020. At the time, we thought this could possibly be the longest bear market on record. Instead, it was the shortest in the history of the the S&P 500.
Those who acted, either by buying when everyone else was selling or taking other such measures to profit from the volatility were rewarded for it.
Lesson #3: Stay calm and look for the opportunities within the chaos.
Let's hope that we are nearing the end of the pandemic. There are positive signs everywhere. Even more importantly, let's hope that when disaster strikes again, that we will be better prepared thanks to the lessons of this pandemic.
Abe Ringer, CFP®
Breakwater Financial, LLC is a registered investment advisor. The content of this blog post is for informational and educational purposes only and is not to be considered investment, legal or tax advice. If you have any questions regarding this blog post, please contact us.