To put it succinctly, it wasn’t a pretty week for equity markets. The number of cases of coronavirus worldwide continued a swift tick upward, prompting the S&P 500 Index to fall more than 12% from a record high, notching one of the swiftest selloffs in history and its worst weekly loss since October 2008 (during the financial crisis).
While that move has certainly been painful, keeping a longer-term perspective is important. We’ve only lost four months of returns, thanks to an impressive rally over the past few months.
A Risk-off Mood
On Thursday, the index entered what is considered a “correction,” or a drop of 10% to (under) 20% from its 52-week high. On days like this, it’s important to remember that selloffs of this nature are normal in a given year and U.S. stocks have weathered pullbacks like this before. For instance, the S&P 500 has recorded five corrections since the start of the bull market, with the last one occurring just 14 months ago.
Stocks are especially vulnerable to these types of drops when valuations climb too high and sentiment becomes stretched — two prevalent characteristics prior to this week’s selloff. To put the recent volatility into perspective, the S&P 500 has gained almost 16% from October 2 to February 21. The index is still valued at a forward price-to-earnings (P/E) multiple of 17.2x, a premium to the 10-year historic average of 15.7x.
Additionally, uncertainty is no friend of the index. As coronavirus headlines continue to pour in, experts and investors alike have struggled to wrap their heads around the extent of the outbreak’s impact on economic growth and earnings.
In the meantime, some investors have chosen to shift out of stocks for now and ride the storm out in safe-haven assets instead. The 10-year Treasury yield closed at 1.15% on Friday — a record low. Investors have also rushed into stock hedges for protection, sending the Chicago Board Options Exchange’s Volatility Index (VIX) as high as 42 during the week. For context, it’s rare for the VIX to even close above 20 — a benchmark that’s happened in just 12% of trading days over the past five years.
The Fundamental Picture
We have yet to see a breakdown in fundamentals, but a few worrying trends have emerged. Companies have started to reduce their 2020 earnings guidance, and executives have pointed to coronavirus as a risk to profits.
Economists are also cutting their U.S. gross domestic product forecasts (GDP), and although few firms are predicting recession this year, slowing growth could be another obstacle for stocks. However, even though economists anticipate a hit to China’s economic data, the flow through to the U.S. should be more limited.
We don’t want to understate the human impact of the coronavirus outbreak, but the economic impact globally should be temporary in nature.
The Road Ahead
The financial market’s path forward could be bumpy. Investors might stay in a risk-off mood until there is more clarity that the worst is behind us. We expect the market to fluctuate as the coronavirus impact is assessed, and while we expect gains to be more muted in 2020, we’re still optimistic on U.S. stocks’s long-term prospects.
Selloffs don’t last forever.
Fortunately, we also have history to inform us that selloffs are finite. Market setbacks are typically followed by eventual recoveries, especially with supportive fundamentals. It’s beneficial to have a long-term investing horizon in these types of situations. During this bull market, which is almost 11 years old, the S&P 500 has taken an average of about five months to completely recover from corrections — demonstrating patience has its virtues.
Volatile days can feel uncomfortable. But they’re a good reminder of the importance of having an investing plan in place, since it can help you weather the normal ups and downs of the market and help you be poised to take advantage of opportunities as they arise.
Now is a good time to review your investments and make sure they are aligned with the timeline for your financial goals and take into consideration your risk tolerance. If you’re an investor with near-term horizons or lower risk tolerances, you should consider looking outside of equities for capital protection.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.