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2 timeless lessons for investors from the past year

Sam Ro
·Managing Editor
·4 min read
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A version of this article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

Monday, February 22, 2021

Things can go badly fast, but the market will look forward

A year ago, the S&P 500 (^GSPC) began its sharp descent from its then record high as the coronavirus started to get seriously priced into the stock market. From February 19 to March 23, the S&P went on to crash 34% from a closing high of 3,386 to a closing low of 2,237.

On Friday, the S&P closed at 3,906.

From that, investors can learn at least two very important lessons.

The first lesson: things can go badly suddenly and swiftly. It goes without saying, but it's worth repeating. Scary stock market sell-offs happen all the time.

Check out the chart below from JPMorgan Asset Management's Guide to Markets. Morning Brief readers will recognize it as we reference it quite a bit. It shows that the S&P 500 sees sharp intra-year drops almost every year, averaging a 14.3% drop since 1980.

Big stock market drawdowns happen all the time. (JPMorgan Asset Management)
Big stock market drawdowns happen all the time. (JPMorgan Asset Management)

These big sell-offs happen for any number of reasons. One unfortunate reason is unforeseen risks. Investors are constantly pricing in the various visible risks the market is facing. But unforeseen risks are generally considered unlikely and won't be priced into the markets at all. That is, until they happen.

Take, for example, the coronavirus pandemic. The negative impact to the economy clearly wasn't priced in on February 19. But it sure was priced in at least somewhat, if not too much, by March 23. During that month, economists were tripping over each other as they cut their GDP forecasts like there was no bottom in sight.

Now, there's lots to be said about what various types of investors should do when the sell-offs come. Ultimately, the secret to making better investments moves when markets are in turmoil is to already have a plan.

The second lesson: the market is forward looking. Investors don't invest in a business because of the money it is or isn't making right now. Investors invest because of all the money that's expected to be made in all the years down the road.

This largely explains why the stock market and the economy appear to decouple. The truth is, it's not so much that they decouple. Rather, they just reflect different things.

"While it’s difficult to pin down a date when we can expect our lives to completely return to normal, the stock market is already pricing in the normalization of daily life, even if that remains uncertain," LPL Financial analysts said on Friday. "Economic conditions around the world have been improving relative to how they were at the beginning of the pandemic. While pockets of weakness remain, the market is more concerned with where the economic conditions will be, not where they are currently." (Emphasis added.)

It's for this reason that stocks rally when things are terrible. It's for this reason why stocks bottom long before the economic data does.

None of this is intended to discount the tragedy of the coronavirus pandemic and the many other horrifying events that unfortunately riddle history.

Rather, it's a testament to human resilience, which is an incredibly bullish force investors can't afford to ignore as they think about where the market is headed in the years to come. A year after economists were warning of a "deep plunge" in activity, those same economists are now saying to "fasten your seatbelts" as COVID-19 cases drop and the economy surprises to the upside.

"It’s our jobs as investors to focus on our long-term goals,” LPL Financial Chief Market Strategist Ryan Detrick said. “Drawdowns and bear markets are part of the path to get there."

By Sam Ro, managing editor. Follow him at @SamRo

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