The perils of trying to time the market
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Over the past three weeks, stock markets across the world have fallen sharply as investors panicked over the potential impact of the novel coronavirus, Covid-19, on the world economy. Many people are asking – should I sell before markets fall further? The answer depends on how accurately market prices reflect the likely impact of the current situation.
The price may be right
The first thing to consider is that stock markets are extremely efficient in factoring in all publicly available information. This means that current prices reflect the informed investor’s view of how current events are likely to play out. If you are selling at current prices, you need to be convinced that either (a) people’s estimates of the impact of the Covid-19 pandemic are over-optimistic, or (b) more negative information is going to come to light . This is the rational approach. However, as we know, when one person in a room shouts “Fire!” everyone tends to run for the door. As a result, in a downturn prices can fall well below their “rational” values. People can easily fall prey to the emotional market cycle – as illustrated below.
Where to from here?
The problem in this case is that we really don’t know: we are entering unchartered territory. Our understanding of the virus and the public policy response is evolving day by day, leading to wild swings in markets. For example, on Monday 2 March 2020, following seven straight trading days of negative returns, the S&P 500 (the index of the largest 500 shares in the USA) rebounded to increase by +4.6% – the fourth best single day return in the last 10 years. This positive performance was surpassed on Friday 13 March, with the index up 9.3% as governments and central banks around the world announced a range of measures to protect businesses.
In addition, when current events are dominating headlines, it is helpful to maintain a sense of perspective. As the chart below shows, even after the recent falls, investors have been handsomely rewarded for staying invested over the past 15 years. Consider this: when you decide to sell in a falling market, you will ultimately need to decide on the right time to re-enter the market – so you will need to get your timing right on two counts. Data from Morningstar shows that an investor who had missed on the 20 best trading days over the past 15 years would have reduced their return by nearly 7% p.a.1 There’s an old saying in the investment world that goes “It’s about time in the market, not timing the market!”
15-year growth of the Moningstar Global Markets (GBP) index. Source: FE Analytics
Markets rise and fall. While recent falls have been steep, evidence suggests that in past downturns markets have recovered reasonably quickly to pre-crash levels. The most recent significant crash, the so-called Global Financial Crisis in 2008, saw markets surpass their pre-crash highs a mere two years after prices began falling.
|Decline type2||Number of times observed||Average peak to trough decline||Duration of decline||Duration of recovery to previous highs|
|-5% or better||55||-1.6%||1.5 months||0.4 months|
|-5% to -10%||9||-6.8%||4 months||2 months|
|-10% to -20%||7||-14.5%||11 months||5 months|
|-20% to -30%||3||-26.1%||9 months||17 months|
|-30% or worse||3||-45.9%||23 months||54 months|
|All||77||-6.1%||3.8 months||3.8 months|
2Based on performance of the S&P 500 Index. A decline of -10%, for example, means that the index fell by 10% from the high at the time the decline started
Very often, as investors our emotions tend to get in the way of doing what is rationally in our best interests. That’s one of the reasons why we have designed our long-term savings plans to encourage investors to stay invested through volatile markets. There will always be periods where returns are negative, but history shows that over time these are more than compensated for by periods of positive performance.
Obviously, there are factors that may influence your personal decision, such as “when will I need to access my savings?” So we’re not suggesting that staying invested is the right approach for everyone. But definitely, think twice before selling on the basis of news headlines. And if you’re in doubt, your best course of action is to speak to your financial adviser.
Past performance is not a reliable indicator of future results. The value of your investments and the income received from them can fall as well as rise. You may not get back the amount you invested.
1Source: FE Analytics, based on Morningstar UK GBP Index and Vitality internal analysis