Insights

How Investors Can Stay Disciplined When Others Are Fearful

Written by Cross Border Wealth | Apr, 20, 2020 - 10:00 AM

The stock market has rebounded strongly since its recent lows in late March. Both the S&P 500 and the Dow Jones Industrial Average have risen around 30%, reducing their year-to-date declines to 11% and 15%, respectively. International markets have also bounced from their lows with both developed and emerging market indices up about 20% over the past three weeks. Due to the strength of recent stock market gains, there is significant investor and media focus on whether the March low represented the bear market bottom, and whether we are in a new bull market cycle.

 

The reality is that it's difficult to tell if the storm has passed or if we're in the eye of a hurricane. 

 

Similarly, identifying stock market inflection points is often done with the benefit of hindsight well after the situation has calmed. Of course, it's very tempting to speculate on not only the timing but the "shape" of the subsequent market and economic recovery. Identifying whether this will be a V, U, W, L, or other letter-shaped recovery is now part of the day-to-day market conversation.

 

This is not to say that what happens from here doesn't matter for investor returns - it clearly does. The point, instead, is that it's unnecessary to try to guess the exact bottom. There are better ways for investors to prepare their portfolios and more concrete and insightful data to follow than simply watching the day-to-day gyrations of the stock market. 

Specifically, at a time when the economic data is lagging and earnings estimates are unreliable, gauges of investor sentiment can be telling. 

 

As the oft-used Warren Buffet quote suggests, it's historically been wise to be "fearful when others are greedy and greedy when others are fearful." There is no better example of this than the bull market that began in 2009 which, by many measures, was "unloved." Sentiment was consistently low throughout the decade-long recovery as investors faced persistent fears of a relapse. Despite this, the stock market generated significant gains. 

Today, despite the recent rebound in markets, various sentiment measures are still extremely bearish. Not surprisingly, investor sentiment has hovered near its historic lows since February while consumer sentiment has fallen to at least 5-year lows. This is driven in no small part by consumer expectations plummeting due to the economic shutdown. These sentiment measures may even worsen as work stoppages continue and the economic slowdown impacts more and more industries, driving unemployment higher and GDP growth lower for a period of time.

The critical factor in the bearish climate is the uncertainty around the coronavirus itself. After all, the catalyst for this crisis wasn't inherent to the workings of the economy or financial system, although elevated valuations and high levels of corporate debt certainly didn't help. The core issue is that, even as recently as March, it was unclear whether it would take weeks, months, or years for the economy to reopen. It was unclear when we would reach the light at the end of the tunnel - or if there even was one.

While there is still significant uncertainty, there are also some emerging glimmers of hope. Measures to "flatten the curve" appear to be working, as shown in the pace of new daily confirmed COVID-19 cases across the U.S., including hotspots such as New York. Evidence from places like China also suggest that life can slowly return to normal and the economy can open up just a couple of months after the onset of the crisis. Of course, this will depend heavily on many variables including continued progress in the fight against the coronavirus and whether the economy can be reopened in a responsible manner.

Ultimately, the challenge for many investors is believing that there is such thing as a perfect market environment - and that waiting for a comfortable moment to pounce is the objective of investing.

Unfortunately, by the time the stars align, it's often too late. For patient investors, the best opportunities present themselves in market dislocations and crises - periods when others are fearful. It's not a coincidence then that these are also moments when it's least comfortable to invest. Thus, the main objective of any disciplined, long-term investor should be to stay balanced and hold a diversified portfolio that is appropriate for their financial goals. This is more important today than ever as other investors continue to be bearish.

 

Below are three charts that help to put bearish sentiment in perspective.

 1. There is evidence that new COVID-19 cases are plateauing

Change in COVID-19 Cases


There is emerging evidence that mitigation efforts and the nationwide shutdown are having an effect on the spread of the coronavirus. This, combined with the experience of other countries, is positive news for providing clarity to the long-term path of the economy. The public policy conversation has now shifted to when and how to reopen the U.S. economy is a responsible manner.

 

2. Economic indicators continue to show the effects of the shutdown

Leading Economic Indicators


The economic data will be gloomy for quite some time due to the lagging nature of economic readings. The index of leading economic indicators turned sharply negative in March and will likely see increasing declines in the coming months.

 

3. Investors and consumers are extremely bearish

Consumer Sentiment


Despite the recent rebound in the stock market, various sentiment measures are still quite bearish. This is true of investor sentiment as well as general consumer sentiment, especially when considering expectations for the future. In general, sentiment is a contrarian indicator - that is, it's valuable to be calm and invested when others are fearful.

 

The bottom line? There are signs that mitigation efforts are succeeding at containing the coronavirus. Although it's tempting to try to time the bottom of the market, it's more important to stay balanced throughout all market cycles, especially when other investors are still fearful.