What an exciting time in the markets! Already in 2020, we’ve had a 6-day correction (drop over 10%) that turned into a bear market 21 days later. Additionally, on Monday, March 9, 2020, the Dow Jone Industrial Average dropped -2,013.76 points, the largest point drop for a single day. The percentage drop was -7.79%, the largest one-day percentage drop we’ve had since 2008.
For many investors glued to the news, the global outlook appears to be perilous with no prospects of growth for the world economy. However, for David John Marotta, this is business as usual. Bear markets are nothing to be feared.
On Tuesday, March 10, 2020, David John Marotta appeared on Radio 1070 WINA’s Schilling Show to examine the market volatility and compare it to normal market movements.
Listen to the audio here:
Did this surprise you?
People have been expecting a drop since 2018’s almost bear market, but this is what the market does.
The market still trends upward. It has bear markets, recessions, and crashes along the way, but it still trends upward. The longer the time period you look at, the less drops there seem to be. There has never been a 20-year period where the markets have been down.
People are looking for a reason to panic. The coronavirus is a great excuse. Whether the narrative is true or not does not really seem to matter to people. People love having an excuse to act on their fear, but it is better to take this chance to consider why you are afraid.
What do you fear will happen specifically? Why does that scare you so much? If that happens, what will you do? Take this as an opportunity to heal yourself, better understand what your money means to you, strengthen your life plan, and plan for emergencies.
Long-term investors have time to recover. You can do this. If you don’t want to do it alone, this might be the time to reach out for help. Feel free to drop us a message or give us a call to get started today.
How does your day-to-day change when the market is dropping?
“Our plan is to do nothing.” As Glassman reminds us, it is the financial media which troubles us into moving in the wrong direction:
I’m not going to guess whether the next move in the market is 10% up or down, I just know that at some point a correction will come. When it does, an 1800 point drop will feel terrible, the news will be covering it 24/7, and we’ll stop talking about the Nats because everyone will be talking about the stock market.
Well, we had drop over 1800 points. It feels terrible. The news is covering it 24/7. Should we panic and get out of the markets? You would do better to do nothing.
A drop like this comes around every 4-6 years. The craziest day in the market was October 19, 1987 “Black Monday.” We survived. We’ll survive this.
Will the markets go to zero?
Once you understand how the market works, you know the market cannot go to zero.
A market maker has a big pile of one company’s stock. When someone wants to buy stock but no one else wants to sell it, the market maker will sell them some from their pile. After a certain number of shares trade, they are allowed to move the stock price up or down based on whether someone is buying or selling. When there are more buyers than sellers, the stock price goes up. The stock price goes down when there are more sellers than buyers.
This is the true reason why stock prices go up or down.
You can imagine that if the price was going down and approaching zero, it would mean that David Marotta could take his pocket change and own all the companies of the world. Long before that happens, Warren Buffet would wake up one morning and think that it was a great day to buy.
This is why the markets will never go to zero. The companies that make up the market are worth far too much to be valued so poorly.
During this season of panic, investors have bought so much in bonds that the bonds are relatively overvalued and investors have fled stock so much that the stock prices are relatively undervalued. Once the fear settles and investors settle down for the long-term again, the market will settle as well.
Why does the market maker want to make a market?
Companies apply to be a market maker, and there are certain rules to follow. Market makers make money on the difference between the bid and ask spread. Sometimes the bid-ask spread these days is a fraction of a penny. They make more money the more times they engage in trades.
There are probably at least a dozen market makers for one large company, like Apple.
Sometimes, the exchanges decide to stop the market. It’s normally a bad idea, but it happened yesterday (March 9) for about 15 minutes.
We had a “Flash Crash” a few years ago because the market was suspended and someone’s market orders without limit prices sold accidentally to another person’s junk purchase order for pennies. The exchanges later went back and reversed all those trades, but it was still the fault of suspending the markets.
For this reason, suspending the markets is normally a bad idea.
Is fear of the virus the reason people are selling?
It doesn’t really matter why people are selling. Any explanation of why people are selling stock is, at best, a guess. Yes, I am sure that some people think that the coronavirus COVID-19 will cause a global recession and are selling stock out of fear that the market will drop further. However, if you believe that narrative is rational, investors would be guessing that the coming recession will cause gross domestic product (GDP) to decline as much as 19%. There hasn’t been a United States recession larger than 19% since 1929.
In 2016, I wrote about “The Narrative Fallacy” and gave “Examples of the Narrative Fallacy” in everyday market news. Neither of these articles proved popular despite my thoughts at the time that this was one of the more important principles for dealing with the financial news cycle. This is a prime example of when to be an informed consumer of investment media, the strongest suggestion of which is to avoid it entirely.
Investors like to say, “My friend lost everything in 2008 and hasn’t recovered.” However, the only way that narrative can be true is if you jumped out of the markets at the bottom and either never got back in or only got back in when it was higher. This is why you shouldn’t jump out.
You can always find a good reason to get out of the markets, but when you will get back in? Whenever you do, it will likely be the wrong time and you would have been better to stay put. Many people who get out of the markets wait until the market is trading at a value higher than when they got out in order to get back in.
At the time of the radio show, we were right on the edge of bear market territory. Usually once the markets are down 20%, the forward returns are phenomenal.
While we can define a bear market as 20% down from the last high, we can’t define a bull market from some prior low. The last low is when the stock market first opened. Now, the markets are up an infinite amount from the prior low. That is why the minute a bear market bottoms it starts the next bull market.
How should I prepare?
Have 5-7 years in bonds so you don’t have to sell your stocks when the market is down to live. One standard deviation of 7-year stock market movements is all positive.
If you have already done that, then just rebalance your portfolio. Sell what is up, buy what is down.
We have a saying around here: It is always a good time to have a balanced portfolio.
Selling bonds and buying stocks will increase your expected return but also increase your expected volatility.
If you are currently withdrawing from your portfolio, consider leaving 7 years of your annual withdrawal rate in bonds regardless of if the percentage is still the same stability target. Otherwise, if you are not withdrawing or already have more invested in bonds than 7 years of your withdrawal needs, I would recommend rebalancing your portfolio back to your original asset allocation targets by selling bonds and buying stocks.
As the stock market trends upward, this dip in market prices can be perceived as stocks being discounted and is likely a great time to buy low.
Photo by Federico Beccari on Unsplash