Investing in the Face of Uncertainty
By Daniel Campbell, CFA
“Risk is what’s left over after you think you’ve thought of everything.”
The stock market seems to be unstoppable lately. Inflation registered at a 13-year high for the second month in a row, and then the S&P 500 broke its own record within a week.1 New variants of COVID-19 threaten to slow global re-openings. Unemployment and labor participation have yet to recover to their
February 2020 levels.2 Yet the U.S. stock market is more than 35% higher than its pre-COVID high.3 All this begs the question – what could possibly bring stocks down?
We believe stock markets are efficient at incorporating all known current information; in 2020, an average of $650 billion traded hands through global stock exchanges every day.4 With that many people expressing a view on different stocks, prices are usually a fair representation of current value. However, we also know that investors can get optimistic about the future. The more optimistic they become, the higher stock prices go and the more likely a little bit of bad news can cause
a big sell-off. Those sell-offs are scary in the moment, but the feelings they create are also easy to forget. For instance, many people have forgotten the day in March last year when the stock market fell over 12%!5
We expect stocks to lose money in one out of every three months. We expect stocks to be down something like once every six years. And we expect a correction of 20% or more once every 10 years.6 Think about this: $1 million hypothetically invested in U.S. stocks 30 years ago would have grown to over $22 million
by the end of 2020. But along the way that investment’s value would have hit a high and then dropped by double digits seven times, including getting cut in half in 2008.7 As we can see in the graph, some of those declines happened fast and the recovery was quick – like 2020. But others were drawn out and the portfolio didn’t recover to its previous high for over five years.
The growth of $1 million hypothetically invested in U.S. stocks over the 30-year period ending Dec. 31, 2020. 7 Despite growing to $22 million, the portfolio once dropped from $5.7 million to $3.2 million (44% decline). It recovered, but within five years dropped from $6.9 million to $3.4 million (51% decline). During March 2020, that portfolio would have dropped from $18.5 million to $14.6 million (21% decline). Large drops in stocks should be expected. See disclosure.
The truth is, we don’t know what will cause the next big sell-off in the market. Investing is a game of odds, and we design portfolios to put the odds on your side. The longer you stay invested, the more those odds tilt to your favor.
Because we don’t know where the next shock will come from (and we don’t believe anyone else does either), we built your portfolio to endure a variety of risks. The next panic could be from a major international event, or it could spring from a seemingly small piece of data that causes investors to rethink their assumptions.
Whatever causes the next scare, knowing history can help. Remember, the path toward portfolio growth has often been littered with double-digit declines. If you found yourself losing sleep over your portfolio’s performance throughout the first half of 2020, consider taking some risk off the table. We balance your stock risk with high-quality bonds so that your personal experience in the market isn’t more than you can endure. Make sure that your portfolio strikes the right balance of risk and reward, because ultimately it will be your decision to stick with your plan through the rough patches that will determine its success.
- Consumer Price Index (CPI-U) for all urban consumers increased by 5.4% before seasonal adjustment based on the July report from the Bureau of Labor Statistics (source: https://www.bls.gov/news.release/cpi.nr0.htm). This report was released on Aug. 11 and the S&P Total Return index hit a new record high of 9,337 on Aug. 16 (source: https://www.spglobal.com/spdji/en/indices/ equity/sp-500/#overview).
- Unemployment was 3.5% in February 2020 and 5.4% in July 2021 (source: https://www.bls.gov/charts/employment-situation/civilian-unemployment- rate.htm). Labor participation was 63.3% in February 2020 and 61.7% in July 2021 (source: https://www.bls.gov/charts/employment-situation/civilian- labor-force-participation-rate.htm).
- Source: Morningstar Direct. U.S. stocks, as measured by the Russell 3000 Total Return Index, hit a high of 10,649 on Feb. 19, 2020. The closing price on Aug. 16, 2021 was 14,555, 36.7% higher than the pre-COVID high.
- Source: Dimensional, Pursuing a Better Investment Experience.
- Source: Morningstar Direct. The Russell 3000 Total Return Index lost 12.3% on March 16, 2020.
- Source: Morningstar Direct. Russell 3000 was negative seven out of the 42 calendar years from 1979-2020, or once every six years. It had four independent drawdowns over 20% over the time period, or roughly one for every 10 years of index life.
- Source: Morningstar Direct. U.S. stocks, as represented by the Russell 3000 Total Return Index, from January 1991 to December 2020. The seven double-digit drops are seven independent events where the value recovered to its pre-drop level before falling by 10% or more.
This article is for informational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based on third- party data which may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio nor do indices represent results of actual trading. Total return includes reinvestment of dividends and capital gains. Performance is historical and does not guarantee future results. The chart is illustrating a hypothetical investment of $1 million in the U.S. stock market for 30 years ending December 2020. The U.S stock market is being measured by the Russell 3000 Total Return Index. IRN-21-2606