Since the last stock market article, I've been quiet on the topic since I wanted to give everyone a chance to try out some ETF investing before we start talking about riskier individual stock strategies. Given a lot of you reading these articles might be new to investing it feels like a great time to talk about dips in the market since we're experiencing one right now.
The S&P 500 is down ~8% this week - it is a significant drop in the market and no one knows whether it will keep dropping or if we've 'hit the bottom' meaning the market will go back up. One note for perspective is that even with this drop it is still up more than 10% in the last 12 months.
I'm not going to go into much detail about the Coronavirus (or Covid-19) itself in this article since it's being well covered, we'll focus more on the impacts it is having on the stock market and what you should be thinking about when considering your options.
Why is Coronavirus having an impact on the stock market?
When a stock decreases in value it means there are more sellers than buyers in the market. Sellers become willing to accept lower prices for the stock they hold in order to sell it which drives the market price of the stock down. Remember there always has to be a someone on the other end of a stock transaction.
So why are there so many sellers at the moment? When looking at big market fluctuations I think about market reactions in three ways.
1. The logical market
Logic says there are cause and effect explanations for market reactions, you can work through these thought processes in your head or on paper pretty easily. What you're trying to work through are all of the industries and companies which might be negatively or positively impacted by this news. You can start with a hypothesis and work your way through.
This is where you need to get your Mr Spock on, and these are the types of companies which are going to get hit the hardest.
Hypothesis - I believe people will travel less because of the Coronavirus since governments and agencies have recommended reduction of travel and there are fears about catching the coronavirus in foreign countries and in confined spaces like aeroplanes etc.
Next, I want to think through what types of companies the reduction of travellers might impact and the follow-on effects from there. Below is a rough mind map showing a few stages - Less travel means less spend on airlines which might mean less spend by airlines on expenditures like fuel (if they reduce their number of flights) and marketing (if they're forced to cut costs) and the companies it might impact.
I would then take a look at my portfolio to understand if and how I'm exposed to these types of companies. Fortunately, I don't have anything in airlines or fuel but Facebook and Google make up a large part of the S&P 500 and are also in my own personal portfolio so I'm fairly exposed there if they are impacted.
What you need to decide is whether you think this situation is going to have a long-lasting impact on the business you're looking at or invested in - we're in it for the long haul. During the 'great recession', Lehman Brothers went out of business because of how involved they were with sub-prime mortgages - 99% of the companies in the S&P 500 who were hit by the drop bounced back and had record performances since.
2. The Emotional market -
This one is a lot more difficult to predict with a mapping exercise.
Behavioural economics 'assumes that people, given their preferences and constraints, are capable of making rational decisions by effectively weighing the costs and benefits of each option available to them.' Notice the issue with that? People don't make rational decisions, they make emotional decisions based on fear, excitement, social influence etc.
Think of the stock market like voting for a second - a lot of people will vote for someone who does not have their best interests in mind because of external emotional factors. This irrational behaviour has been personified by some as a character called 'Mr Market'. It's helpful to think of the stock market as a person, Mr Market, going about their day making decisions based on their mood swinging from exuberance to panic based on what they read in the news, see on Facebook, hear from a friend etc.
This irrational behaviour explains why companies who may or may not be impacted by the Coronavirus are being impacted by the sell-off as investors run wild selling everything and hiding their cash under the mattress.
Keep your cool. It's really difficult to not get caught up in the emotions and follow the herd into a panic but know that you can't predict the emotional market's behaviour and also that it's unlikely the movement is being driven by rational information you haven't had access to.
3. The algorithmic market -
'80% of daily (trade) volume in the U.S. is done by machines' Guy De Blonay, fund manager at Jupiter Asset Management.
Banks, hedge funds, and institutional investors use trading algorithms to automate a lot of their work and reduce human error and oversight. Simply put they are systems programmed with a set of rules which will buy and sell stocks based on a variety of inputs like industry news, market movement, and loss predictions.
Unfortunately, you can think of them more like a very complex drip coffee machine trying to predict when to turn on to make a cup of coffee than a cool R2D2 robot. These algorithms dramatically increase the speed at which trading decisions can be made however they can also cause mass sell-offs since a large institution or two starting a selling pattern will likely trigger other algorithms to start selling too, it's like a huge domino effect.
So what should you do in times like these?
The main thing is to not get caught up in the hysteria everyone else is in, you might not actually need to do much at all - which is always nice. Read this fictional story of Bob the worst market timer and how he still made a huge profit simply by not selling stocks despite buying right before the biggest down markets.
Do not cancel your regular market buys unless you think there is an underlying issue with the investments and that they won't recover. If you only invest when the stock market is going well you're always going to be buying at the most expensive price. Buying good stocks now presents a great discount in comparison to a few weeks ago.
Here's a handy checklist:
Remind yourself of your investment plan and strategy - you're in this for the long haul, these short term fluctuations shouldn't impact your regular market purchases much and give you a chance to bring your average costs down when buying great stocks.
Review your portfolio against the 'logical market' rational above, are there companies in your portfolio which you feel are directly impacted and won't recover? You might think about selling those before they drop further, I didn't have any.
Try to remind yourself of the mood swings of 'Mr Market' and the sell-offs algorithms can cause and don't less this stress you out. If the S&P 500 collapses we'll have a lot more to worry about than losing a few % on our stock investments, since we won't even be able to buy anything with our money. I'm not predicting a zombie apocalypse any time soon - so the S&P 500 and its top companies still look pretty good to me.
Go on the offensive - using the same thinking as the 'logical market' rational you can identify companies which are going to do well in this situation. Zoom a video conferencing software company's stocks have flown up on the news since more people will be taking meetings virtually until this blows over.
There are much more important things to be thinking about like keeping yourself, family, and friends healthy than letting the stock market stress you out! Turn off your notifications on Robinhood if needed, be happy and healthy first.
As always I'm very open to any feedback or questions and subscribe if you're interested to keep up to date!