[Updated in our blog entry of 2/27/20]
The stock market’s at all-time highs, and now faces a new threat in addition to the impeachment trial, trade wars and Middle East instability: the threat of a deadly global pandemic. What should stock market investors do, if anything?
If history is any guide, investors may not have a lot to worry about, except in certain sectors, and for a limited period of time (see chart below). Over the last 40 years or so, stock returns have been almost uniformly positive even when under threat from epidemics. Of course, there’s no guarantee. If the current epidemic spreads widely and proves to have a high mortality rate, this time could be different.
The stock market’s price level represents the sum total of millions of trading decisions, based on every factor investors think will affect earnings and prices stretching out into the future. Studies have shown that large numbers of people tend to estimate very well. Taken together, this means that stock prices generally reflect all known information with remarkable accuracy. Today’s (January 26, 2020) modest market drop of a little over 1% in U.S. stock indices represents somewhat increased investor concern, as the initial news of China’s coronavirus becomes known. But it is not given to us to see what will happen tomorrow, or next week, or next month. There are simply too many unknowns when it comes to predicting the course of this new disease and its impacts.
The inescapable rational conclusion is that we have no business trying to anticipate the market’s future movements, any more than the course of this new disease. But there is one investing discipline that can decrease risk and increase returns: rebalancing.
Rebalancing an investment portfolio means hewing to pre-determined allocations to stocks, bonds and cash. That is, it means shifting money from out-performers to under-performers when prices shift. Thus, if stocks drop, as may occur in coming days, our discipline would prompt us to shift money from other asset classes (e.g., bonds) into stocks.
Not only does this take advantage of emergent investment bargains, but keeps our overall portfolio risk where we have set it in our planning. That’s a rare double-win, or free lunch, as we say in the investment business.
In a future article, we will cover the subject of rebalancing in greater detail. In the meantime, call us if you have questions. And remember to wash your hands and stay safe! Here’s a link to the Centers for Disease Control’s coronavirus prevention page: https://www.cdc.gov/coronavirus/about/prevention.html.
— Peter W. Johnson, Jr.