Plan for the market comeback, not its immediate setback

Last updated on 13th May, 2020 at 10:37 am

When markets plummet, panic rises. But basing decisions that will impact your future wealth on yesterday’s market volatility is an unwise move, cautions Shawn Phillips, research and investment analyst at Glacier by Sanlam.

Despite 2019 being a year of uncertainty, investors were rewarded for staying invested in risky assets. Globally, equities were the place to be with, the MSCI World surging 24.11% (in rand terms), while most regional equity indices gave investors solid returns with the S&P 500 leading the charge.

Locally, the JSE All Share Index (ALSI) advanced 12.05%, while local bonds gained 10.32%. The result? We entered 2020 with optimism, supported by signs of stablising global growth and progress on the trade war between the US and China. That said, sentiment has since rapidly changed with two overwhelming issues creating fear in the market and reminding investors of the 2008 global financial crisis.

What’s causing the current market volatility?

The first issue has been the coronavirus in China. The second has been the sharp fall in oil prices due to the price war between Saudi Arabia and OPEC (The Organization of the Petroleum Exporting Countries).

Given that we live in an interconnected world, the impact of the coronavirus has been far reaching. The concerns are around the potential impact on global growth and whether this will lead to a global recession, as well as how other countries will contain the virus.

As a result, volatility has spiked and we have seen a flight to safety. Year-to-date in rand terms (1 January 2020 to 9 March 2020), global equities gave up 3.61% and global bonds surged 19.58%, while local equity surrendered 15.03% and local bonds firmed 0.07%. The depreciation of the rand has helped offset the losses of foreign returns. If you isolate the period of distress (25 February 2020 to 9 March 2020), global equities surrendered 9.61% and global bonds rallied 10.12%, while local equity and local bonds gave up 10.73% and 2.09%, respectively.

Don’t make an emotional decision

It’s during times of market stress that investors make emotional decisions such as switching their investments to cash, which could hamper long-term wealth creation.

It’s worth remembering, however, past times of market stress in order to understand what investors should – and shouldn’t – do during times like these.

Why you shouldn’t let the past dictate your decisions for your future wealth

As humans, we suffer from a number of biases which can lead to irrational behaviour, especially during stressful situations.

For example, consider the worst daily drawdown experienced on the ALSI from 28 February 1997 to 28 February 2020 in the graph below (-11.92%). While this return is perceived like a disaster – and investors tend to assume this will continue in the future – this isn’t necessarily a true assumption to make. This bias is known as recency bias, and the danger of this bias is that it skews our view of reality as well as the future.

The 10 worst days on the ALSI from 28 February 1997 to 28 February 2020
The biggest daily loss has been -11.92%, while the best loss of the 10 worst daily returns has been -5.73%. The average loss across these 10 data points was -7.14%, which is roughly in line with what investors experienced on 9 March 2020 on the ALSI.

Source: IRESS

The subsequent returns, following the 10 worst daily returns experienced on the ALSI
In the graph below, the y-axis shows annualised returns, while the blue dot represents the 10 worst daily drawdowns (ranked from worst to best; left to right on the x-axis). The corresponding bar charts show the subsequent returns after those drawdowns occurred.

Take a look at the 10th worst daily return. The subsequent returns were: 1.63% (one-year); 16.86% (three-year) and 16.09% (five-year). When you look at the 10 worst days, it’s clear that the following one-year, three-year and five-year returns have been compelling.

The average subsequent returns after the 10 worst returns were: 25.17% (one-year); 16.61% (three-year) and 17.60% (five-year).

Why does this matter? Because even when markets drop, it’s critical to remember: they will recover, and they will deliver returns in the long-term.

Source: IRESS

You’ll be rewarded for staying invested

During these sharp drawdowns, it’s extremely difficult to stay invested or – better yet – to use this as an opportunity to enter the equity market.

But the data suggests that’ll you be rewarded for staying invested, and that equity markets do, in fact, rebound.

The experience of these drawdowns and how investors react are critical for future returns. At this juncture, investors are faced with two decisions: either stay invested or switch to cash. However, this requires investors to time the market, which is an extremely difficult task.

As always, it’s important to remain calm and to stick to your long-term investment plan. It’s during times of market stress that investors understand their willingness and ability to take on risk, which should be adequately reflected in their underlying investments. It’s crucial to work with your financial planner to make sure that you’re invested according to your correct risk profile, which should go a long way in allowing you to navigate this volatile market and the years beyond.