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Perspective NewsletterThe word “unprecedented” has been getting an awful lot of use recently… and appropriately so. In just the last seven days we’ve observed a truly remarkable series of events:

  • Countries imposed drastic measures to limit the international and domestic spread of the SARS-CoV-2 virus. For the first time in history, the Canada-US border was closed to nonessential travellers.
  • Around the world, governments unveiled an unprecedented array of fiscal policies to ease the sudden financial strains inflicted on industries, businesses, and households, and hopefully prevent a broadening economic downturn.
  • The Federal Reserve initiated an unprecedented 100 basis point emergency rate cut (its second emergency cut in as many weeks) bringing US interest rates back to near-zero.

In response to the heightened uncertainty, the already extreme market volatility intensified and stocks continued their decline. On Friday, the S&P 500 index closed 31.9% below its February 19th closing high.

We’ve been down this road before

While the rate of this decline has been more abrupt than in past episodes, the magnitude is not without precedent. The last 100 years have witnessed seven bear markets exceeding a 32% decline, and most of us are old enough to have experienced at least a few of them first-hand.

Table 1: Significant Bear Markets of the Last Century

(Please note: this table is best viewed horizontally on mobile devices.)

S&P 500 Bear Market Decline (duration) Decline (percent) Next 12 Months Return (percent) Next Bull Market (duration) Next Bull Market Return (percent)
2007-09 1.4 years -56.8% +68.6% 11.0 years +400.5%
2000-02 2.1 years -48.9% +33.7% 5.0 years +101.5%
1987 0.3 years -33.5% +21.4% 12.8 years +579.2%
1973-74 1.7 years -48.2% +38.0% 12.9 years +440.7%
1939-42 2.5 years -43.4% +53.6% 6.1 years +128.4%
1937-38 1.1 years -54.4% +29.1% 1.6 years +55.4%
1929-32 2.7 years -86.1% +121.4% 4.8 years +324.3%

Source: Standard & Poors, based on daily closing price index (excl. dividends)

Each of these bear markets had different causes and followed different paths, but they all had a few things in common:

  • The onset, duration, and magnitude of the declines were wholly unpredictable.
  • Those investors who managed to endure the bumpy ride were significantly rewarded for doing so in the 12 months following the trough.
  • Investors who sold during the decline, in addition to locking in what would have been paper losses, would also have missed out on the start of the some of the best returning periods in the market’s history.

Maintaining perspective

While informative, the narrow focus on specific bull and bear markets, each of which might last for months or years, is far too short in the context of a family’s goals, which can extend decades into the future. Broadening our perspective to look at the market over several decades, it becomes difficult to pick out where each of those individual bear markets occurred on the chart. When we take a step back to look at the big picture, we can better appreciate that what seems enormous at the time, might not be as significant as it first appears over the term over which goals need to be met.

Figure 1: US Equity Market Price History

S&P 500 Price Index
Source: Standard & Poors, based on daily closing price index (excl. dividends)

Focus on goals, not markets

We know that the markets will inevitably recover, simply because the temporary conditions that feed bear markets can’t last forever. Market sentiment is a short term phenomenon. It invariably swings from one extreme to the other, and it does so unpredictably. Based on what we’ve learned from history, we don’t attempt to guess the direction that stocks might move in the short term, or attempt to time exactly when this bear market will bottom. Instead, we keep our hands on the wheel and our eyes on the road ahead, maintaining discipline and staying focused on ensuring that our clients can achieve their goals.

It can be easy to lose perspective and become distracted by everything that is going on in the economy and markets, but it’s helpful to pause and ask “Am I still on track to achieving my goals?” Despite the current selloff, the answer should still be “yes”. Funds for longer term goals can typically endure short term market dislocations without putting the future goals at risk.

Looking at it another way, it can be helpful to remember that life is a movie, not a snapshot. Neither the recent market index high point of February 19 nor the current low of March 20 are really relevant to individual clients. The pertinent number for most people is really the amount of cash flow that a portfolio will produce over a lifetime or over generations (along with other cash flow sources such as income, a business sale etc.). For most clients, this current decline is unlikely to seriously affect the ability to achieve their goals.

The goals based approach to navigating selloffs

Northwood’s approach always begins with the understanding that everyone’s goals are different, as is their capacity and tolerance for risk. Risk capacity is the amount of financial capital buffer each client has to withstand losses. Risk tolerance is largely a function of the ability to ride out market losses, and for many investors, this is what is being tested right now.

For each client we’ve developed a diversified asset mix intended to navigate difficult markets, and provide the liquid cash flow to fund needs when required. Assuming ones goals haven’t changed, it’s seldom necessary to make any large changes to an asset allocation. There may be small adjustments, as market risk and return expectations are adjusted higher or lower, or as assets are rebalanced to keep portfolios near their target exposures. But these are minor details. Achieving goals ultimately requires having a robust plan, and also the discipline to stick to it during the ups and downs.

Recall that these investment plans were developed while clearheaded and sober, and realize that the emotions that arise in markets such as these can impair rational decision making. The most detrimental response in a selloff is to allow emotions to take the place of reason, to lose sight of goals, to deviate from the planned path, and ultimately to fall victim to the bear market by making the wrong moves at the wrong time.

Staying on track

Business news broadcasts are already filled with sensationalist market commentaries from prognosticators, doomsayers, and bottom-callers. However, we recognize that none of them have any innate predictive powers. Medical and public health authorities indicate that the viral threat and the mitigation measures may persist for some time. However, the length of this challenging market and the speed of its recovery will be a mystery until we look back at this time in the records of historical bear markets.

We’ve been down this type of road before, and our planning includes provisions for the high likelihood that we would inevitably run into conditions like this again, while always being mindful that it’s impossible to predict exactly when.

If you would like to discuss further, please contact your Northwood client manager.

Northwood Family Office

Tom McCullough

Tom McCullough

Tom McCullough is Chairman and CEO of Northwood Family Office, which looks after the investments and integrated financial affairs of wealthy families with $10 million or more. He teaches ‘The Management of Private Wealth’ in the MBA program at the University of Toronto’s Rotman School of Management, and is also co-author of the books, Family Wealth Management and Wealth of Wisdom: The Top 50 Questions Wealthy Families Ask.

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