In light of the latest COVID-19 outbreak, and the recent oil price-war, the world is seeing another ongoing stock market crash that started in February of 2020. Many states (and some countries) have declared a state of emergency. Business has slowed down, many small businesses have come to a standstill. Analysts have lowered their expectations of world GDP growth, as people and governments try to contain the spread of coronavirus. This market crash is not new. The world has seen over 50 recorded stock market crashes since the 1600s, the earliest recorded being the one that busted the Tulip Mania Bubble in 1637. A market crash is typically followed by depressed economic activity or an economic recession.
What is a recession
A recession is extended period of economic decline. There is no official definition of a recession. However, the International Monetary Fund or the IMF uses many different measures to determine if we are in a recession. Some measures are per capita GDP, industrial production, trade, capital flows, oil consumption, and employment. A decline in these measures for several months is considered recession territory. Here is a link to the IMF blog on recession.
The National Bureau of Economic Research maintains unofficial dates for the start and end of recessions in the United States. During a recession, economic activity declines, trade declines, unemployment rises, stock markets decline, home prices decline. Some recessions can last several years, such as the Great Depression of 1929, which lasted about 4 years. Some recessions are short-lived, like the one in 1980, which lasted for 6 months. Typical recessions in the United States have lasted about 11 months, on average.
Will the market recover after the 2020 coronavirus market crash?
Typically, after a market crash, the market continues to decline or grow at a very slow rate, compared to the pre-crash rate. It takes a few months, or in some cases, years, to come back to the pre-crash high.
Because of the coronavirus, we will continue to see a period of declined economic activity. Here are a few things that we may see.
- Travel will reduce, impacting the airline, cruise, and hotel industry.
- Entertainment industry will suffer, as people will stop attending sporting events, movies, concerts, etc.
- Consumer spending on discretionary items will decline as people stop going to stores and malls. Even with online shopping, people will continue to be wary of whether their goods are being shipped from areas with widespread infections.
- There will be supply chain disruptions.
- Unemployment will increase, wages will decrease, as companies try to cut costs caused by reduced consumer demand and supply chain disruptions.
- Increased unemployment will, in turn, reduce consumer demand and decrease consumer confidence.
- Increased unemployment may cause consumers to go into default on their mortgages and homes may go into foreclosures, reducing home values.
- Government spending will increase on trying to contain the virus and easing the economic impact caused by the virus. Thus, spending on technology, infrastructure and other economy building activity will reduce.
After almost all historic stock market crashes and recessions, the stock market has grown to higher levels than the pre-crash high, even though it has taken varying amounts of time for economic activity to return to pre-crash normals. I don’t think it will be any different this time.
Likely economic impact of COVID-19
There are 3 scenarios that I can think of.
- In the first scenario – the coronavirus impacts a majority of the world population, decimating a lot of us. In this case, it won’t matter whether the stock market recovers or not. We will have bigger things to worry about.
- In the second scenario – the virus spread is contained but it takes a significantly long period of time (in years) for economic activity to get back to normal. Recessionary environment prevails for a few years before economic activity picks up again.
- In the third scenario – all major governments take significant steps to contain the spread through school closures, business closures, travel restrictions. In this scenario, economic activity returns to normal in a few months.
I am no epidemiologist or virologist, however, in my opinion, scenario 1 is highly unlikely. Scenarios 2 or 3 seem more likely. Probability of scenario 3 seems much more likely than scenario 2.
How to approach financial planning in 2020 given the stock market crash?
If you have debt
- If you have been aggressively paying off your debt before the coronavirus outbreak, it may be time to put that on hold. Keep your cash and stay paying only minimums on your debt. You will need cash handy, especially if you haven’t built up an emergency fund. These are trying times. Some industries, such as hospitality, airlines, cruises, hotels, restaurants, etc. are in for months of financial hardships. Many people will see a job loss or wage cuts in the coming months. You want to save your cash for that time.
- Talk to your lenders. If you expect your wages to go down, you may be able to ask your lenders, landlord, credit card companies, utilities, etc. to lower your interest rate or to allow you to skip a payment without incurring a penalty.
- Halt all your discretionary spending. Stop using your credit cards for your wants. Spend only on necessities. These tough times will not last forever. This is true for people who don’t have any debt.
- If you have an emergency fund set up, you may have to dip into your savings. Don’t worry. This is what you have been preparing for. These tough times will be over before you know it and there will be plenty of time to build that emergency fund again.
If you have kids
- Prepare for alternative child care service costs. With school and daycare closures, you may need to seek alternative services. Check if a co-op exists in your county where you can share childcare responsibilities with a group of other parents. Make sure you limit the group to a few families to maintain social distancing, and yet be able to secure much needed childcare, especially for families that work in the healthcare industry.
- Check out state and county programs on alternative childcare services.
- Don’t be afraid to ask grandparents if they can help care for your child while you have to work.
If you have no-to-minimum debt
- You want to continue contributing to your emergency fund if it’s not fully funded. If you are not sure whether your job will be secure or if you are expecting your wages to decline, don’t worry about investing at this point. Secure your financial position so you can survive financially in case of a layoff.
- If you have a fully funded emergency fund, you may be able to take advantage of the plenty of investment opportunities this stock market crash might bring.
- Help out others in need, if you have the ability to do so. Some families will be hit hard. Offer financial assistance or try to hire local, or buy local to support small businesses in your community.
What are my Investment options during the stock market crash of 2020?
If you have a brokerage account or a 401k or an individual IRA, you may have noticed the decline in the total size of your assets. Some of you may be in a state of panic and want to get out of the market this very instant and keep all assets in cash. This will be a terrible move. I cannot tell you when your investments will go up in value but I can assure you that they will. However, if you sell off now, you will lose more than if you had stayed invested.
We have always said that investing is a disciplined approach, if you want to keep growing your wealth. Don’t chase exciting new stocks. There are professionals who work follow specific sectors and stocks day in and day out. You are not going to beat those analysts or high frequency traders through your selection of individual stocks. Read our article on efficient market hypothesis to understand what I mean. Do what you do best. Make investing as boring as possible. Keep investing in broad market indexed funds and grow wealth through the power of diversification.
Investment strategy in 2020
Has the stock market hit its bottom? How much further is it going to fall? No one knows. If someone tells you that they can predict the market bottom or time the market, RUN!! If they tell you to pick stocks to beat the market, run twice as fast. No expert can tell you when the stock market will bottom out.
So what’s the best strategy? Keep investing at your predefined intervals. If you get paid monthly, set a date each month to auto-transfer a certain percentage of your net pay into your brokerage account. Invest that amount into a broad market indexed fund. Vanguard has several options. VTI, VOO are a couple of tickers that come to mind if you want to be invested in the broad US market. Consider VXUS, if you want exposure to international markets. It’s time in the market that will make you rich, not timing the market.
Historic market recoveries after market crash
Now let’s look at how the market has recovered after market crashes. There is no clear definition of a market crash but I have analyzed historic data going back to 1928 before the Great Depression where the S&P 500 dropped by at least 5% in one day. Note that in the United States, market trading halts when the S&P 500 sees a 7% drop in market value.
Since 1928, there have been 75 days where the index saw a drop that was at least 5%. The below table shows how the index moved after the 5% drop happened. For example, the day after the 5% drop, the index was back up by 0.88%, on average. The average weekly return after the drop was 1.87% and in 1 year, the index returned an average of 17.85%. In 10 years, the index was up by 162.7%. However, you can also see that the best returns and worst returns have a wide range. For example, the 1 year return after October 23rd 1929, the index was -35.56%. 1 year after the 1932 market crash, the index returned 125.6%.
Average, Median, Best and Worst returns after historic market crashes
|Return after ↓
The above table tells you a story of how the stock market recovered after 75 significant market drops. This link from the National Bureau of Economic Research shows all historic recessions and their durations.
I understand that times are tough. They are likely going to last for a while but they are not going to last forever. Hang in there. If you have debt, it’s time to keep cash at hand. It’s okay if you need to dip into your emergency fund. Ask for help. If you have no emergency fund, continue to build it. If you are invested, now is not the time to sell off. You can use this opportunity to continue to invest. If you have the ability to help someone in need, please do.
Tough times don’t last but tough people do.
Stay safe, live well, spend time with family.