To say that 2020 has been a roller coaster of a year for the economy and the financial markets would be an understatement. Interestingly, as we approach the midpoint of the year, the overall performance of broad stock market averages has been much less pronounced than the macroeconomic dislocation may have warranted. As COVID-19 morphed into a pandemic in late February, the stock market suffered a dramatic decline, resulting in a meaningful bear market within a matter of weeks. Investor sentiment had shifted dramatically from euphoria to despair. But the stock market hit a low in late March and has recouped much of the losses over the following three months.
Rather than making grand predictions regarding stock market performance in the second half, I believe it is essential for investors to better understand how markets function and how investors should react when markets are in disarray. Gleaning lessons from prior investment mishaps is a key ingredient in achieving one’s long-term financial and investment goals. Many people have a fundamental misunderstanding of how the stock market functions. They enter the market when economic growth is strong and then bail out when the market is swooning. I have heard some claim that the stock market is “rigged.” Nothing can be further from the truth. I will offer a few ideas over the next few weeks on how to develop disciplined investment skills. By developing these skills, one can avoid fundamental errors that less-disciplined investors are prone to make.
Avoid Market Timing
Attempting to time the market could be one of the more costly mistakes. Those who believe they can anticipate when the stock market is about to rally or decline are likely to lose money. Investors should understand that the stock market is a leading indicator of the economy. The decline in the stock market this year began prior to the pandemic spreading in the United States. Moreover, the stock market began to recover in late March, well before the peak of the spread of the COVID-19 pandemic.
The phenomenon of the stock market as a leading indicator of future economic performance has been evident during many major cycles over my career. In the summer of 1982, the stock market launched its prolonged bull market in the midst of one of the worst recessions since the Great Depression. In early 2000, the technology stock bubble began to burst, well before the economy slipped into recession in 2002. In 2007, the stock market peaked nearly a year before the financial crisis led us into the “great recession” in late 2008. In March 2009, the stock market began its decade-long bull market run, even as the economy was still recovering from the financial crisis.
During some of the worst bear markets, I have had clients call me and ask whether it was time to throw in the towel and liquidate. My standard answer is: I do not believe in timing the market. I do believe that investors can only ensure healthy returns over the long-term if they do not try to time the market.
Several clients called me this past March, inquiring whether it was time to get out. I explained to them that the only reason to get out of the market, in the midst of a sharp decline, is when one’s financial goals have changed. In other words, if their financial condition has changed, then perhaps one should consider a reassessment of their allocation to equities. But investment decisions should not be driven by market volatility.
I was able to help clients understand that selling into a bear market could result in devastating consequences. Let us say that one began a long-term investment program in the beginning of the year. If they had invested in a broad portfolio of stocks, they would probably have seen their nest egg shrink by perhaps over 30%—but only on paper. If they decided at that point to liquidate, they would have locked in substantial losses. Moreover, they would have missed the recovery and would be left with the undesirable choice of what to do now with all that cash earning virtually no interest.
Yes, there are professionals and others who sometimes are able to call the top or bottom in the market. But getting it wrong even once can cause substantial financial damage, not to mention emotional trauma, that may jeopardize one’s financial future.
Jonathan D. Caplan, a former Wall Street executive, is president and founder of wealth management firm Caplan Capital Management, Inc., with offices in Highland Park and Hackensack. He holds a BA from Yeshiva University and an MBA in finance from New York University Stern School of Business. You can find other recent investment articles by Jonathan at www.caplancapital.com/blog.
The views presented are those of the authors and should not be construed as personal investment advice or a solicitation to purchase or sell securities referenced in this market commentary. The authors or clients may own stock or sectors discussed. All economic and performance information is historical and not indicative of future results. You should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice. All information is obtained from sources believed to be reliable. However, we do not guarantee the accuracy, adequacy or completeness of any information and are not responsible for any errors or omissions or from the results obtained from the use of such information.