As you might expect, we’ve had tons of messages about investing and selling assets during the outbreak. It’s a strange time we’re living in as the world is in turmoil. The majority of businesses that can do so have told their employees to work from home and many have to prepare for lay-offs. Countries are closing their borders and the stock market has crashed.
To bring our two cents to all of this, we decided to answer a question posted by Magali, a freelancer from Belgium. She wanted to know how an outbreak like the coronavirus could affect her investments. Should she sell her assets and wait for better times, invest more than usual, or continue following the plan she developed in calmer times?
Without knowing what’s inside Magali’s investment portfolio, we have summarised what we know so far about the impact of the coronavirus on the economy, what the past can tell us about the future, and what an outbreak like the coronavirus is likely to mean for passive investors generally.
How the coronavirus affects the economy
Right now, with so little information circulating about the coronavirus and its impact on the economy, uncertainty is extremely high. In other words: it’s not an ideal time to make decisions. The markets have been on an upward trajectory for the last twelve years and many had already predicted an upcoming recession. The tricky thing about a recession, though, is that it’s usually caused by something that no one has expected. Except for Bill Gates of course, who predicted in his TED talk from 2015 that a virus would bring down the economy. But besides Bill, who knew!
Factories in China are still closed because people are forbidden from going to work. A similar pattern is emerging across Europe. Italy was the first country in the EU to go into lockdown and as we’re writing this, many countries have followed suit. Supermarkets in France have long queues to prevent overcrowding and close interactions. In Texas, it’s not the supermarkets that have queues, but the gun shops.
The rapid spread of what is now a pandemic has put enormous strain on the machinery that makes the global economy turn. As a result, we have seen stocks plummet more in one day than ever before.
Although the increase in the number of COVID-19 experts popping up online is bordering on the exponential, like the virus itself, we won’t offer any predictions for what will happen with the pandemic. However, what we can do is look back on historical events that damaged the economy, and see how the world was able to recover then.
The Spanish flu
The Spanish flu can provide a comparison to the coronavirus. The Spanish flu was a deadly influenza pandemic that infected a quarter of the world’s population between January 1918 and December 1920. There were twice as many deaths from the Spanish flu than there were casualties of World War I. The final death toll is estimated to have been anywhere from 17 million to 50 million, making it one of the deadliest pandemics in human history.
The Spanish flu not only caused unimaginable human suffering, but also immense economic impact. The S&P 500 index, a benchmark made up of the 500 largest US-listed companies, fell in value by almost 25% in 1918.
The Spanish flu caused what seemed to be irreparable damage to the world’s economic activity, but it managed to recover surprisingly quickly. The market rose by 9% in 1919 as the death toll began to reduce, and recovery was taking shape. Within a few years, the markets were back at their pre-pandemic levels.
In a previous article in which we answered one of our reader’s questions, we analysed how the markets recovered following the 2007-2008 financial crisis and how it would have affected a passive investor. There too we saw that recovery was surprisingly fast.
It’s said that during a crisis, we are often too optimistic at the start and too negative about the recovery, which will happen sooner than we realize. In the past twenty years alone, viruses like Zika, SARS, swine flu, bird flu and Ebola have all caused global panic. Yet, somehow, we’ve managed to recover quicker than might have been expected. See from the graph how quickly the tide turned in each pandemic. In a pandemic, the market tends to follow a “V” shape, with a sharp drop and fast recovery.
Disease outbreaks have taken place throughout human history and will continue to do so.
Scenarios for the future
It’s impossible to demand certainty when investing in equity. It’s like demanding a never-ending spree of sunshine and blue skies, in order to go outside. Even if you decide to minimise your risk of bad weather by moving to a warmer climate, hurricanes can reach tropical sands too.
To emphasise this point, former hedge fund manager and author of “Investing Demystified” Lars Kroijer explains, “the fact is that unless we have genius insights or a crystal ball, we almost certainly don’t know the future direction of the markets or even individual securities”. You can hear more of Lars Kroijer’s insights in our interview with him.
Nothing is safe from the virus. Individual assets, such as your house and job, could well suffer as your investments. The only thing standing between the drop in real-estate prices and the market are banks and their leniency. The fact that you lost 30% of your portfolio’s value might feel like an unnecessary slap in the face during an already difficult year, but it will pale in comparison with lay-offs and potential unemployment.
In the case of the coronavirus, we’ve seen a panic sell as economies of various countries slowed down, as a result of mandated lockdowns. We can see at least two scenarios that could emerge:
1. The “world is ending” scenario
The world will never be the same and we’ll forever be trapped in an eternal lockdown. Entire industries will disappear and the economy will never recover. Would your credit card keep working? Will banks still exist? In such an apocalyptic scenario, the best move is to sell your investments (stocks, bonds, gold) and keep only cash and property.
2. The “we’ll figure out how to live with this” scenario
The world will learn how to live with the coronavirus, just like it did with the “regular” flu, TBC, HIV, etc… With all the measures in place, the spread will be stopped. A vaccine will be found. Countries will stop their lockdowns one by one and life will continue like it was before. The global economy will recover. In this scenario, we advise you to continue investing because in a not-too-distant future, your investments in the stock markets will recover and thrive.
Which scenario is more likely?
We can only guess, but looking at history, the second scenario seems more likely. If we look at the past century, no event has managed to cause irreparable damage to the global economy, forcing it to crumble and never recover. And we’ve had some pretty horrific events that decimated our population and economy, including the Spanish Flu pandemic, World War I (20 million deaths), and World War II (70-85 million deaths). Just over the last 20 years, we’ve seen the dot-com crash, the 9/11 attacks, Ebola, the swine flu, SARS and the 2007-2008 financial crisis.
Still, is this time different? It’s definitely possible. But we shouldn’t forget that we are prone to cognitive biases, especially in times like this. The coronavirus is dominating our lives at the minute. Are we really seeing the facts objectively or are we forming our own narrative that mixes facts and emotion? Decades of research on human psychology teaches us that it’s more the latter. The narrative in our heads does not change the facts of a situation but it can easily change how we respond to those facts.
Steps you can take
Moving forward, we can look at similar events in the past and take lessons from them. If history is any guide, coronavirus is likely to cause a significant, but temporary, pullback as it continues to spread. It can be devastating to watch your assets drop so rapidly and you’ll likely experience nerve-racking emotions as an investors, but this is exactly why being rational is advantageous throughout this uncertain climate:
- If you are still earning a salary and have enough savings as a nest-egg if things turn sour, continue investing in your investment portfolio as if these were normal times.
- The coronavirus has shown the importance of an emergency fund. Several people around us have had to take a pay cut or have lost their salary, even if only temporary. Being able to tap into an emergency fund with 3 to 6 months worth of living expenses can save you a lot of financial headaches to get through those times.
- History tells us that the economy recovers faster than expected after each recession. When you’re young and saving for retirement over a 30-year period, a recession is a setback for sure but it passes. In the end, you will still make an impressive profit when the markets rise up again.
- Every day that you’re not investing your money, you are passing on profits. Given that no one knows how long this crisis will last or when the markets will continue to rise up, the smartest thing you can do is start investing as early as you can and be consistent with your investments.
Resources which inspired us
- Lars Kroijer’s article “Investing in the face of a disaster”
- “What happened to stock markets during previous pandemics?” by Fidelity
- Ben Felix on Market Crashes (Is This Time Different?) (video)