Global stock markets have witnessed one of the sharpest weekly declines since the 2008 global financial crisis as the world grapples with the wider spread of Covid-19, a type of coronavirus. In this blog, we try to put the market impact in context.
So, what happened this week?
What’s happened is that investors have reassessed the economic impact of the virus. Until recently, investors expected the coronavirus outbreak would be largely contained within China. There have already been positive signs of containment in China, for instance a fall in the number of diagnosed cases.
Although a big economic impact was always expected, the emergence and acceleration of the virus in Italy, South Korea and Japan has caused investors to worry the economic impact may be larger than originally thought. This fear is heightened by travel restrictions and the opaque nature of increasingly global supply chains, which make it hard to understand where the supply and demand impacts will be felt most keenly.
Financial markets don’t like uncertainty, and that’s why we have seen a flight from risky assets such as equities towards “safe haven” investments such as government bonds and gold. It’s not all bad news. Government bonds, particularly US treasuries, have performed well in February with bond yields reaching all-time lows (when yields fall, bond prices rise and investors gain). However, in the past five to ten days most Nutmeg portfolios have suffered losses due to the negative performance of global equity markets.
How concerned should you be about volatility?
Most of the losses in equity markets have come in the past five days. In fact, if you look at five-day performance periods for the S&P 500, an index of the top 500 listed companies in the US, you’ll see that the past five days rank among the worst 0.5% of all five-day periods since February 1990.
However, we’ve often seen that after a sharp decline in equity markets, the following 12-month period delivers positive returns. Since the beginning of February 1990, there have been 48 five-day periods in which the S&P 500 fell more than 7%. The average return in the 12 months following these losses was more than 16%.
As we’ve discussed before, falls in stock markets within a year are commonplace. In market terms, we call these “corrections”. In the chart below, the orange dots show the biggest US stock market corrections in each year since 1990. With a few exceptions, the stock market finished the year positively – see the green bars.
The conclusion? Volatility and corrections are a normal part of investing in equity markets and it pays to be disciplined when markets are volatile. If we look at the years since the global financial crisis – 2009 and onwards – we can see that in every year except 2018 the US stock market delivered positive returns for the full year despite some fairly large corrections.
What should I do about it?
It’s possible that stock markets will fall further in the near term. However, often the smartest decision you can take in response is to do nothing. Timing markets is incredibly hard, and although no one likes to see their portfolio value go down, it’s important to resist the temptation to tinker with your risk level.
The reality is that volatility is business as usual in financial markets. We tend to forget this in periods of relative calm, but the reason we focus on diversification as a core investment principle at Nutmeg is because volatility is a natural part of investing. Our investment team continue to review portfolio positioning and you can read about how we have responded to the spread of the coronavirus here.
It’s really important to remain disciplined, focus on your long-term investment goals and ignore the short-term noise of headlines whenever we have a period of volatility in markets.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past performance and forecasts are not reliable indicators of future performance.