Epidemics, Market Declines and Planning Strategy

Around the world a spreading coronavirus is raising distressing concerns. Will it be contained or become a pandemic? Uncertainty has been experienced globally, and it is unsettling both on a human level and for investors concerned how a spreading epidemic may impact their portfolios after recently seeing the biggest market declines since the panic of 2008.

It is a fundamental principle from modern financial science that competitive capital markets are designed to handle financial uncertainty, as they process information in the form of prices through trading almost instantaneously. Information is processed when markets decline and as they rise. Excessive attention paid to media headlines during plunging market declines is distressing, of course, but such price volatility simply demonstrates the efficiency of financial markets functioning as unbiased aggregators of information repricing expected returns.

Exhibit 1: What Affects a Stock’s Current Price?

graphic, What Affects a Stock's Current Price?

Using all available information, a stock’s current price — or a group of American or Chinese stocks comprising their home markets — reflects the aggregate financial expectations of participants about risk and return pertaining to that security from the past, present and even anticipated future information. Market declines occur when informed participants must reassess their future expectation due to negative “news” as it is almost instantly incorporated into that stock’s price or the price of a group of securities.

The spreading of an epidemic outbreak worries governments, companies, and individuals about the potential impact on their domestic and the global economy. Apple announced earlier this month that it expected revenue to take a hit from problems making and selling products in China.1 Australia’s prime minister has said the virus will likely become a global pandemic,2 and other officials there warned of a serious blow to the country’s economy.3 Airlines are preparing for the toll it will take on travel.4 These are only a few examples of how the impact of the coronavirus is being assessed.

The market quickly responds not only to new information becoming known, but in pricing potential unknowns, too. As risk increases uncertainty, so investors demand greater returns for bearing risk. Those demands push prices lower and expected returns higher. Our entire management strategy of multifactor investing depends on the fundamental economic principle that prices adjust to deliver positive expected returns for investors who hold risky assets.

We can’t tell you when the decline will reverse. Our expectation is, however, that disciplined clients who bear risk will be compensated with positive expected returns. That’s been the lesson of health-related crises in the past, such as the Ebola and swine-flu outbreaks, that cause temporary market disruptions, and those epidemics did not impede recovery from the Tech Bust of the early 2000s or the global financial crisis of 2008-2009.

Additionally, studies of market history have shown no reliable way to identify a peak or bottom. This argues against investors taking actions outside of investment policy guidelines based on fear of loss or greed for gain, even as traumatic events transpire. Looking at the U.S. market’s resiliency through multiple past epidemics gives perspective on the advantage of a disciplined investment approach for planning.

Exhibit 2: Epidemics and U. S. Stock Market Performance Since 1980

chart, S&P 500 Index Price Performance chart, Epidemcis and S&P Price Performance

Source: Bloomberg, as of2/24/20. Month end numbers were used for the 6- and 12-month % change. *12-month data is not available for the June 2019 measles. Past performance is not a guarantee or an assurance of future results. The S&P 500 Index is an unmanaged index of 500 stocks used to measure large-cap U.S. stock market performance. Investors cannot invest directly in an index. Index returns do not reflect any fees, expenses, or sales charges. Returns are based on price only and do not include dividends. This chart is for illustrative purposes only and not indicative of any actual investment. These returns were the result of certain market factors and events which may not be repeated in the future.

CONCLUSION

The portfolios of Dimensional Fund Advisors play an important role in helping clients stick with an informed strategy through changing economic and political conditions. We educate clients to be aware of possible extreme outcomes, positive and negative, when deciding on an investment policy. We review your policy regularly to make sure it still fits your situation. Our planning assumes inevitable market downturns. Amid the anxiety of such times, decades of financial science and academic-level research guide our process and our judgement.

Focus on the long-term: Working with Professional Financial, your strategy is exceptionally well-diversified. Your investment portfolio is coordinated with your wage income and your current or future Social Security, pensions, annuities and reverse mortgages. Make changes only as lifestyle needs and family objectives change. Don’t let media noise and fear run your life. Stay in good health and spend time with family and friends doing things that truly matter. That’s why we are here — to worry for you.

FOOTNOTES

1Apple, February 17 press release. https://www.apple.com/newsroom/2020/02/investor-update-on-quarterly-guidance/

2Ben Doherty and Katharine Murphy, “Australia Declares Coronavirus Will Become a Pandemic as It Extends China Travel Ban,” The Guardian, February 27, 2020. https://www.theguardian.com/world/2020/feb/27/australia-declares-coronavirus-will-become-a-pandemic-as-it-extends-china-travel-ban

3Ben Butler, “Coronavirus Threatens Australian Economy Reeling from Drought and Fires,” The Guardian, February 5, 2020. https://www.theguardian.com/business/2020/feb/05/coronavirus-threatens-australian-economy-reeling-from-drought-and-fires; Ed Johnson, “Australia Says Economy to Take ‘Significant’ Hit from Virus,” Bloomberg, February 5, 2020. https://www.bloomberg.com/news/articles/2020-02-05/australia-says-economy-to-take-significant-hit-from-virus

4Alistair MacDonald and William Boston, “Global Airlines Brace for Coronavirus Impact,” The Wall Street Journal, February 26, 2020. https://www.wsj.com/articles/germanys-lufthansa-makes-cuts-as-it-braces-for-coronavirus-impact-11582712819