Afford Anything - PSA Thursday: How Bad Is the Stock Market Crash?

Episode Date: April 30, 2020

Welcome back to PSA Thursday, a segment in which we talk about how to handle money, work, and life in the middle of a pandemic. Today, our focus is on money - specifically, the stock market. Why did it crash in March? What effect did that have on us as a society? Why has it rebounded in the middle of a shutdown, and what does that mean? Are valuations too high relative to earnings? How can we handle our investments and retirement savings at a time when the movements of the market seem irrational and unpredictable? We explore these questions in today's episode. Learn more about your ad choices. Visit podcastchoices.com/adchoices

Hey there, and welcome to PSA Thursday. This is a series of bonus episodes that we air ostensibly weekly, ish, in which we talk about how to navigate your way through pandemic life. How do you manage your work, your daily budget, and your investments in the midst of this uncertainty? We've all experienced rapid change that's affected every aspect of our lives from our work to our wallets to our health. We're living in a world that was completely unimaginable two months ago. And we're trying to handle increased responsibility in a time of high anxiety and high uncertainty. These weekly-ish PSA episodes are one of the many ways in which I'm hoping to help this community and help myself make sense of how to manage our limited resources, our money, our time, our energy in the context of these rapidly changing circumstances. And today, we're going to talk about the stock market.

Why did it crash in March? What effect did that have on us? as a society, why has it rebounded in the middle of a shutdown? What does that mean? Is the market behaving irrationally? Are valuations too high relative to earnings? And most importantly, what do you do about it in your own financial life? How do you handle your own investments, your own retirement savings at a time when the movements of the market seem irrational and unpredictable? and at a time when a reasonable person could argue a case that supports either the idea of an imminent recovery or the idea that this recession could turn into a depression. A person could reasonably make a case for either of those ideas, and both of those projections would have support.

So how do you handle your money when the range of possible outcomes is so wide? That's what we're going to discuss right now. And for those of you who are tuning in for the first time, my name is Paula Pant. This is the Afford Anything podcast. Welcome. Now, to understand the current economy, let's take a look at history. We have U.S. stock market data that goes back to 1871, so 149 years. In that time, bear markets, which are defined as market declines of 20% or more, and which often incite panic and fear among investors, bear markets are incredibly common.

And yet, the long-term pain and damage inflicted by these bare markets, has huge variation. At one end of the extreme, you have the 1929 market crash, which kicked off the Great Depression, or you have the lost decade of the early 2000s, a period that includes the 2008 Great Recession. That's one end of the extreme, the other end of the extreme, are bare markets that felt shocking at the time, and yet that history has largely forgotten about. There was the panic of 1907, which was terrifying at the time. The market fell by 50% in three weeks, sliced in half in less than a month,

and yet the recovery was so quick and the long-term impacts, for those who didn't convert paper losses to real losses, the long-term impacts were so negligible that now the panic of 1907 is a historical footnote. Here we are, a little over 100 years later, having largely forgotten about it. There was the Bering Brothers crisis of 1890, which was the Lehman Brothers of its time. In fact, it was worse. Bering's Bank of London nearly collapsed. Fortunately, it ultimately didn't.

Many people feared that if it did collapse, that would create a domino effect that would lead to the collapse of the entire private banking system of London, which would have triggered a depression. As it was, the Bering's Bank crisis led to a severe recession all around the world, including in the United States. And yet, despite how terrifying of a time that was, the market ultimately had a quarter of a quarter of a quarter of a crisis. quick recovery, and today it is widely forgotten about. We remember the market crash of 1929, even now nearly 100 years later, that example, is cited frequently, and yet these other two crises, which unfolded 22 years earlier and 39 years earlier, respectively, those crises have fallen out of collective consciousness and today are remembered only by history buffs.

Or for a more recent example, what about the flash crash crash? of 1962. The market tanked by almost 23% and didn't recover until the end of the Cuban missile crisis. Now, 1962 was relatively recently. There are a lot of people in this community who were alive in 1962, or 1952 or 42. As a society, 1962 is in our lifetimes. And yet that bear market is still a historical footnote. And so what we know from observing 149 years of stock market history is that every bare market, every market crash feels impactful at the time, but it is only with the benefit of hindsight that we are able to know which of those market crashes led to a sustained period of economic pain and which of those market crashes became a

distant memory. Last week, I did a lot of binge reading about market crashes, and it struck me that there are at least three characteristics that determine or influence the impact of a crash. One is speed, how fast did the market drop? Another is severity. How much did it drop? And then a third is duration. How long did it take to recover from peak to trough? Speed, severity, and duration. All three of those influence the impact of a market crash. The Great Depression was monumentally tragic because it featured the worst of all three of those characteristics. In a single day, October 29th, 1929, the market plummeted with incredible speed. It was not a slow decline.

And that level of speed shocks people. There's an immediate emotional impact because when the market drops so substantially in a single day, that's when you know that your fortunes could literally be wiped out tomorrow. and that creates incredible psychological anxiety and uncertainty. We all still talk about Black Monday, October 19, 1987. My birthday, not the year, but the date. The market tanked almost 23% in a single day. And that combination of speed and severity made that crash incredibly emotionally impactful.

In fact, hospital admissions spiked on Black Monday, 1987. That level of sudden change is stressful. And that same thing happened October 29th, 1929. Like Black Monday, it had speed, it had severity, but the difference between the two, the defining difference, is the duration of the fallout. October 19, 1987 had those first two factors. It featured speed and severity. Those factors were present, but duration was not.

The market recovered quickly. and because that duration is short, that event did not make a significant impact on people's net worths or people's portfolio performance. The only people that were hurt were those who panic and sold, the ones who converted those paper losses into real losses. But as long as you hold your holdings, as long as you don't convert paper into real, then in the long term, that event did not have a significant impact on most people's long term investment performance. their long-term financial future. Contrast that with 1929 that had that same speed and severity, but the duration lasted for seven years. The market didn't recover until November of 1936. And when the duration of the downturn is that long, we develop scars that last for a generation. I mean, those of you who come from families that have lived in the United States since the 1930s or earlier,

you probably have grandparents or great-grandparents who spent the rest of their lives doing extremely frugal things, maintaining their resourcefulness, maintaining their frugal habits even 50 years, 60 years, 80 years after the crash. So again, the emotional impact of a market crash is determined by its speed and its severity,

but the long-term net worth impact is determined by severity and duration, and particularly duration. And so with that historical context established, let's look at the March 2020 market crash. What happened in the stock market in March? And what do we think or feel happened versus what actually happened? Because the crash in March 2020 also had the factors of speed and severity.

And it also layered on top of it, it contained the element of surprise, or really the element of shock, that was influenced not just by what was happening in the markets, but the reason why it was happening. Many of us, those of us who are not in the medical field and who are not disease researchers, many of us, myself included, had adopted a mindset in which we were cognizant of non-communicable health risks,

such as heart failure or stroke or lung cancer. Many of us were thinking about those and trying to manage lifestyle factors, nutrition, exercise, sleep, smoking, that would improve our odds in the world of non-communicable health risks. But for a lot of us, the threat of infectious disease wasn't really on the radar. Pandemics like the bubonic plague seemed like they belonged firmly in history. And even outbreaks like Ebola or SARS felt like things that happened in other countries, but that we were protected from due to the fact that we live in the modern U.S. But then in March of 2020,

not only did we deal with the shock and speed and severity of the market crash, but we also concurrently dealt with needing to radically alter our framework of reality because it had simply never occurred to us, to many of us, that an infectious disease could so rapidly bring us to our knees. Contagious diseases were never on my radar. I've never in my life been afraid of diphtheria until now. And I say that as someone, my aunt had smallpox. My dad's sister, she suffered from smallpox. She survived. Even now, to this day, she still has the smallpox scars on her face. But even, even them and I, like, we all kind of figured, you know, that was Catmandoo in the 1950s and 60s. This is the United States in 2020. Like we

had a sense of security that was based on time and place and forgot that viruses are still a thing. So that recalibration of reality and managing that gap between expectation and reality, that amplified the emotional experience of the March 2020 market crash. It had speed, severity, and shock. But what we've learned from history is that just because a crash feels severe doesn't mean that its financial impact will be severe. And so the recovery that we've seen in the month of April. And of course, it's not a for recovery, still not even close, but the rise in stock values

may be a reflection of some investors saying, look, there is a rough timetable for all of this. We don't know when there will be a coronavirus vaccine or cure. We don't know how long the economic impact will last, but we're talking maybe 2021. we're assessing the impact in terms of six months, 12 months, 18 months, 24 months, we are not assessing the impact on the scale of five years, 10 years. And so the expectation that the economic impact will be relatively short-lived, and again, when I say short, I mean one or two years instead of seven years or eight years, that may be part of the thinking behind the rebound.

Now, critics of the rebound will say, rightfully so, that corporate earnings are going to be decimated this year, and therefore stocks are priced too highly. The valuations are too high relative to expected earnings, which is probably true. And quite frankly, that was also true back in January and February before the market crashed. Before many of us had ever even heard the word COVID-19. Valuations were high back then, and they're high now. And yet many investors keep buying in. And one reason, a reason that, People kept buying in in 2019 and in early 2020. And the reason they may be continuing to buy in now is because simply there is no other better place to put your money. Interest rates are at an all-time low, which means you don't want to invest in bonds. And while it's great to have a strong cash position, eventually there's only so much cash that you can hold. And so if bonds aren't a good option and cash has a limit to how much you want to keep around, well, then what choices are you left with? Commodities, reeds, equities? Commodities and reeds are never going to be something that investors in mass flock into. So for many investors, equities it is,

adjusted for a long-term outlook. So that may be another portion of the reason for the April 2020 market rebound. And finally, the third and perhaps most counterintuitive factor is that the shutdown has negatively impacted fewer sections of the economy, smaller portions of the economy, than one might initially presume. Now, that's not to take away from the many, many people who have been financially hurt by this, from the workers who have lost jobs or from the small businesses, mine included, who have seen their revenues plummet. But the question is, how many and by how much?

So let's look at some data. First of all, huge industries, such as agriculture, utilities, construction, logistics, health care, public services, and some manufacturing are considered essential services, or act as key suppliers for essential services. Those industries, which have been exempted due to being considered essential, comprise approximately 70% of US GDP, according to estimates from Morningstar. Now, this 70% figure may sound high, but that is because for many of us, we do not see the workers in these industries on a day-to-day basis. We don't see utility workers or agriculture workers or logistics workers on a daily basis. What we do see are the non-essential, non-exempted businesses, such as restaurants, hotels, offices, retail stores, gyms, hair salons, bowling alleys, tattoo parlors. those are the businesses and workers we encounter, and as a result, the availability heuristic causes many of us to overestimate the size of those industries as it relates to overall national GDP.

But those businesses that I've just named have a relatively high ratio of social interactions per unit of GDP. And what that means is that we can cut down on social interactions drastically without having to cut down on GDP proportionately. Again, I'm citing Morningstar in their economic impact report. Now, of the 30% of non-exempted businesses, about half of them can maintain their operations or can maintain the bulk of their operations through remote or online working. Law firms, accounting firms, financial planning firms, architecture firms, consulting firms, these are all businesses that may have seen their revenue impacted with regard to client demand,

but they are still maintaining the bulk of their workforce and transitioning to a remote working model. The industries that have been hardest hit are high visibility, high social interaction industries, food services, hotels, airlines, brick-and-mortar retail, and arts and entertainment. Now, these hardest-hit sectors account for just over 15% of GDP, but nearly 30% of U.S. employment.

So what we are seeing is huge numbers of people filing for unemployment, for which measures like the SBA Paycheck Protection Program or enhanced unemployment benefits or the extension of unemployment benefits to self-employed workers, those measures are critical to address the huge unemployment. But the level of unemployment that we're seeing is disproportionate to the impact that the closures of those businesses have on overall GDP. again because these are the sectors that have the highest degree of social interaction per unit of GDP. Now, that's basically another way of saying that national output will remain stronger than many people assume based on the unemployment numbers that we're seeing. And while it's certainly true that high unemployment is going to affect consumer demand, it's also equally true that consumer demand in online retail has jumped to such an extent that many online retailers simply can. cannot keep up with the pace of orders. In fact, one of our podcast sponsors, a company that delivers household essential products like cleaning supplies and personal care supplies to your doorstep, one of that sponsor contacted us and said, hey, we just can't keep up with all the

demand. We need to cancel our next couple of ad spots because we are actively not trying to court any new business. We're overwhelmed with the demand that we already have. So going back to the original question of why is the stock market so high? As of the time of this recording, I'm recording this in the last few days of April of 2020. As of now, the Dow Jones is at 23,775. That puts it at January 2019 levels. So to the question of why is the stock market, at 2019 levels, everything sucks. We're in the middle of a global shutdown. We're facing a deadly pandemic for which there is neither a vaccine nor a cure, why is the stock market at 2019 levels right now? Well, the fact that many analysts expect GDP to not be harmed by this as much as the unemployment

numbers would suggest, or as much as the average individual investor may assume, that may be one of the reasons why the stock market is doing well. And to be clear, I am not making a case or trying to take a position that the stock market should be doing well. I am not advocating for or supporting or taking any type of stance on where the market, quote, unquote, should be. And on principle, I do not engage in the practice of making any types of statements about where the market, quote, unquote, should be. So just to be very clear, that is not at all what I am doing. I am simply taking a look at where the market currently is and then, offering a list of possible explanations as to why the market is where it currently is.

Again, not saying it's right or wrong, but simply trying to add context and clarity to what is a confusing situation. Many people are taken aback by the current performance of the market. Many people quite rightfully say, wait a minute, everything sucks. Why is the market high? and the reasons that I have just offered, including short duration of pain, stronger economic outlook than people may have initially feared, and no better place to invest your money because bonds suck. Those three factors are potential explanations as to why the market is where it currently is. So what does that mean for you? As an individual investor, as somebody who has a 401k and an IRA and who's wondering what moves to make next, how does this apply to you? Well, number one, remember that when people panic and sell, they don't think to themselves, I'm panicking right now. Instead, they rationalize their decision. So you may be tempted to say, wow, look at the unemployment numbers. Wow, look at the risk that we reopen too early and then there's a second wave and that's going to trigger a second shutdown and that will lead us into an economic depression. Wow, based on all of those risks, maybe I should pull some of my money out.

out of the market, put it in cash, so that if the market continues to crater, my portfolio won't get any more beat up than it already has been. That oftentimes is the thinking and the rationale behind selling low and behind converting paper losses into real losses. And so my hope is that what I have just explained for the last 20 minutes will act as a shield and a safeguard against going down that path of reasoning. because the most important thing that you can do, the action that separates strong, long-term investors from those who underperform the markets is hold your holdings during a market downturn.

Do not sell. Do not turn your paper losses into real losses. Just hold. Hold. And if that requires blocking your 401k website from yourself, if that requires installing parental controls on your own computer so that you can't go to the Vanguard or Fidelity or Schwab website for the next three months, then do that. If that requires removing deleting apps from your phone so that you can't obsessively check your portfolio balance, do that. If that requires changing

the password on your investment accounts to something that you could never reasonably memorize, and then writing down that password on a scrap of paper, and then giving it to you, a sibling or a spouse with strict instructions to not let you retrieve your own password for another three months, four months, six months, do that, do whatever it takes to protect yourself from the greatest threat to your portfolio, which is yourself. Again, the cliche that we often hear don't panic and sell is, I believe, incomplete advice. It tells you what to do, but it doesn't tell you how to do it, nor does it tell you why people do it. What's more effective is a dictum such as don't rationalize selling low because people don't think they're panicking. People think they're being

rational, they're being reasonable. Never hold in a down market. Somebody of actions, there's someone who actually said that to me in 2009, never hold in a down market. And he sounded so sure of himself. He had this air as though he was espousing great financial wisdom. Never hold in a down market, don't hold stocks while they're falling. It would be easy for a lesser educated investor to believe that, because on its face it sounds so reasonable. But as we know from hindsight, 2009, which was the year in which I heard this person say that, selling in early 2009 was the worst possible time to sell. February and March of 2009 was when, The market finished dropping.

The market finished taking its hit, and the recovery began. So a person who sold in 2009 took the hit but missed the recovery. That's what happens when you don't hold your holdings. That's what happens when you try to time the market. You look around in the year 2009 and you say, wow, unemployment is still high. All my friends are out of work. My portfolio is in the pits. My house is worth half of what I paid for it.

That's how people were feeling in 2009. and that's exactly when the recovery began. And those who were scared out of the market not only missed those gains, but then once the calendar turned to 2012, 2012, 2013, 2014, then they looked back, they saw that they had missed those gains,

and they said, well, man, I'm kicking myself for having missed those gains, but now, now I'm afraid that the market is too high, so I'm going to continue to sit it out. You know, oops, shucks, it's too bad I missed that recovery, but I'm not going to buy in when the market's so high right now. And people said that in 2012, 2013, 2014, and then they missed the next six to eight years of gains that followed. And so the key takeaway that I hope that you learn from today's PSA is that you may think that the economy is going to be in the toilet this year.

And you might be right. Or you may think that stocks are overvalued right now, relative to expected earnings, and that what goes up must come down, and that when investors realize that stocks are higher than they should be, we'll have another crash, perhaps one that's imminently due in the next couple of weeks or months. You might think that, and you might be right. But you also might not be. Nobody knows, time will tell, and the most important thing that you can do, regardless of what you think the future holds. is to hold your holdings. And not let any guesses about the future, not let any rationalization convince you to lock in your losses. And that is the key message from today's PSA Thursday. Thank you for being part of this community.

My name is Paula Pantt. This is the Afford Anything podcast. If you are tuning in from home, don't forget that we have created a free guide to pandemic productivity. How can you be more effective when you work from home? How can you continue to do your job and meet your responsibilities in this time of high anxiety? We've created a free guide full of tips that can help you stay productive and focused,

even in the midst of all this chaos, and you can download that at afford anything.com slash productive. That's afford anything.com slash productive. You can find me on Instagram at Paula P-A-U-L-A, P-A-N-T, and you can find me at Twitter at Afford Anything, where throughout the week I share thoughts on everything from the market to the economy to real estate to your personal budget. How do you deal with all of that against this background, this backdrop of managing pandemic life? So again, that's Instagram at Paula Pant or Twitter at Afford Anything. And you can download our free guide to pandemic productivity at affordanything.com slash productive.

Thank you so much for tuning in. And I will catch you in the next P.O.S. episode in which we're going to be talking about the impact that this pandemic has had on the real estate market. So make sure that you hit subscribe or follow so that you don't miss that or any of our future upcoming episodes. We're also in an upcoming episode going to be talking to Dr. Sarah Stanley Fala. She is the author of The Next Millionaire Next Door, which is the sequel to The Millionaire Next Door. She is the daughter of one of the co-authors of the Millionaire Next store, the late Dr. Thomas Stanley, we will be discussing how your personality impacts the way that

you manage your money and your investments and how an awareness of that can help you be better at managing your money and your investments. So again, that's coming up on a future episode of Afford Anything. Make sure that you hit subscribe or follow in whatever app you're using to listen to this show so that you don't miss that interview or any of our awesome upcoming episodes. Thank you again for tuning in. My name is Paula Pant. This is the Afford Anything podcast. I'll Catch you in the next episode.