Fear & Greed – The Twin Evils Of Poor Decision Making

What emotion is driving the market?

What emotion is driving the market now?

• Extreme fear is driving markets currently as investor worries hit historic levels based upon the uncertainty surrounding the viral
outbreak.

• Historically, when emotions swing to the extremes, poor investment decisions follow like currently when fear instead of
fundamentals are driving the decision making.

• Fear, like greed, have typically fared poorly as an investment making tool for investors.
 A Historically Swift Downturn

• There are 10+ historical market periods in which the stock market fell further then it currently has. What is different this time is
how historically fast the decline has occurred which is unprecedented in history.

• In the global financial crisis of 2008, stock markets fell approximately 60% from peak to trough but that occurred over an 18 month
time frame.
 Bear Markets and Forward Returns
Here are the other 12 bear markets that are worse than the current version along with their ensuing
one, three, and five year forward returns.

• While unsettling, markets drops like this have occurred throughout history with a downturn in equities of this magnitude occurring
approximately once every decade.

• One consistent element between all major market drops have been the correspondingly significantly higher market moves afterwards
 Equity Market Drawdowns, 1990-2015:
Historically Commonplace

• The past 20+ years have seen multiple significant downturns; two of which saw drops precipitously more pronounced then the
current volatility.

• The unfortunate common theme during these bouts of volatility is investors deciding to sell stocks (as denoted by the “-” sign)
during the exact wrong time just before markets began to recover.
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 Returns of S&P 500 – Missing the best days is disastrous

• Trying to time the market is extremely difficult to do. Market lows often result in emotional decision making. Investing for the long
term while managing volatility has historically led to better performance outcomes.

• Market data – in the form of invest flows in stocks, bonds, and cash – continue to show that market participants are making the exact
wrong decision at the exact wrong time. Attempts at market timing continue to be exposed as failed strategies. As highlighted, just
missing a few of the best performance days, which typically immediately proceed the worst performing days, quickly erodes overall5
portfolio performance.
 China COVID-19 Cases – A Positive Trend

• Using the trajectory of China, which is at the epicenter of this viral outbreak, infection rates have dropped dramatically after
policies were implemented to slow further spreading.

• These policies are only now starting to be implemented across the United States so the expectation has to be that new reported
infections will continue to accelerate in the short-term however China’s containment is encouraging.
• As graphed, Chinese economic activity dropped precipitously during viral containment but has recently re-accelerated
dramatically. For example, all 42 Apple manufacturing facilities have re-opened in mainland China and over 80% of total Chinese
workforce is back on the job.

• Using the Chinese experience as the example, economic activity will contract quickly but recovery very rapidly.
• All of the major outbreak zones, as circled in black, are in the same climate zone. The hope is that as warmer weather pushes
northward it will have a positive effect on containing Covid-19.

• As these climate conditions push northward, into less populated areas of the world, this will hopefully reduce spreading too.
 Length of All U.S. Recessions on Record

• The Spanish Flu that ravished the world in 1918 killed approximately 50 million people worldwide as it quickly spread through the
rapid movement of soldiers involved in WWI.

• The recession brought on by the Spanish Flu was the second shortest on record as the economy quickly recovered as the viral 9
outbreak subsided
 A History of Market Ups and Downs
S&P 500 Index total returns in USD, January 1926–December 2019
Using a 20% threshold for downturns

Bull Market
815% 936%
844% 815%
1,000% 167 181
155 153
months months
months months
451%
130
S&P 500 Index Total Return (Logarithmic Scale)

months
193% 144%
44 months 77 months
108%
76% 61 months
30 months

0%

-22% -22% -29% -30%

6 months 6 months 19 months
-43% 3 months -45%
21 months 25 months -51%
16 months

Bear Market
-83%
34 months
-100%
-1%
6 8 1 3 6 8 1
2 2 3 3 3 3 4 4 4 4 5 5 5 5 6 6 6 6 7 7 7 7 8 8 8 8 9 9 9 9 0 0 0 0 1 1 1 13 6 8 1 3 6 8 1 3 6 8 1 3 6 8 1 3 6 8 1 3 6 8 1 3 6 8 1 3 6 8
.
a n - u l - a n- ul - an - u l - a n- ul - an - u l - a n- ul - an - u l- a n- u l - a n- ul - an - u l- a n- ul - an - ul- an- ul - an - ul- an- u l - a n- ul- an- ul - an - u l - a n- ul-
J J J J J J J J J J J J J J J J J J J J J J J J J J J J J J J J J J
Source: S&PJdata © 2020 S&PJDow Jones Indices LLC, a Jdivision ofJ S&P Global. All rights reserved.

• While bear markets, defined as a -20% or greater market decline, are unpleasant in real-time, they have always been followed by
periods of robust growth and market returns.
 Interest Rates

• Interest rates have fallen dramatically recently as a U.S. 10-year Treasury bond is yielding 0.73% annually.

• When factoring inflation in to the real purchasing power of bond yields, a 10-year U.S. Treasury bond is yielding negative interest.
 S&P 500 Index: Forward P/E Ratio

• After the recent market downturn, stocks are no longer expensive across multiple metrics.

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 Coronavirus will disproportionately damage highly
exposed sectors
High Exposure Moderate Low
Apparel Beverages Construction/materials
Automotive Manufacturers Chemicals Defense
Automotive Suppliers Manufacturing Equipment and
transportation
Consumer Durables Media
Rental
Gaming Metals and mining
Packaging
Lodging/Leisure and Oil and gas/oilfield services
Tourism Pharmaceuticals
Property developers
Passenger Airlines (China) Real estate, REITS
Retail Protein and agriculture Food/food retail
Global shipping Services companies Telecoms
Steel producers Waste management
Source: Moody’s
Technology hardware
• All segments of the economy will be impacted by Covid-19 but each sector will be impacted in different ways.

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• As quarantine measures are implemented and consumers come to the realization that essential services (like grocery stores and
gas stations remain open) that could prove calming to a worried population inundated with rumors and mis-information.
 Unemployment Set To Accelerate
The U.S. unemployment rate has never topped 11% in records dating back to 1948.

• As the effects of Covid-19 start to show up in the economic data, the assumption has to be made that the unemployment rate will
spike to levels unseen in the post WWII era.

• The headlines will get worse but the unknown element is how much of this is now being factored in to stock prices.
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 Maintain Diversification & Avoid Emotional Selling

• A balanced portfolio of both aggressive (stocks) and conservative (bonds) investments has performed very well over the past 20
years although that time period encompassed two separate major downturns not including the current volatility.

• Cash, which is often an asset class that is tempting to move assets in to while volatility is elevated, has historically been a poor
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investment decision compared to other alternatives.
 The Market’s Response to Crisis
Performance of a Balanced Strategy: 60% Stocks, 40% Bonds
Cumulative Total Return

After 1 year After 3 years After 5 years

81%
76%

61%

52% 51%
47%
42%
40%
36%
33%

23% 25%
19%
16%
12%
7%
2% 2% 4%

-2% -1%

October 1987: August 1989: September 1998: March 2000: September 2001: September 2008: August 2011:
Stock Market Crash US Savings and Asian Contagion Dot-Com Crash Terrorist Attack Bankruptcy of US Debt
Loan Crisis Russian Crisis Lehman Brothers Downgrade
LTCM Collapse
Represents cumulative total returns of a balanced strategy invested on the first day of the following calendar month of the event noted. Balanced Strategy: 12% S&P 500 Index, 12% Dimensional US Large Cap Value Index, 6% Dow
Jones US Select REIT Index, 6% Dimensional International Value Index, 6% Dimensional US Small Cap Index, 6% Dimensional US Small Cap Value Index, 3% Dimensional International Small Cap Index, 3% Dimensional International
Small Cap Value Index, 2.4% Dimensional Emerging Markets Small Index, 1.8% Dimensional Emerging Markets Value Index, 1.8% Dimensional Emerging Markets Index, 10% Bloomberg Barclays Treasury Bond Index 1-5 Years, 10%
FTSE World Government Bond Index 1-5 Years (hedged), 10% FTSE World Government Bond Index 1-3 Years (hedged), 10% ICE BofA 1-Year US Treasury Note Index.

• A balanced risk-profile portfolio has historically been able to handle previous market shocks with very strong 5-year returns.

• Stocks and bonds both serve a purpose in any well-diversified portfolio.

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Many Investors Follow Their Emotions

Elation

Optimism

Optimism Nervousness

Fear

Following a reactive cycle of

People may struggle to excessive optimism and
separate their emotions fear may lead to poor
from their investment decisions at the
decisions. worst times.

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 Focus on What You Can Control

• Create an investment plan to fit

your needs and risk tolerance.
A financial advisor can
• Structure a portfolio along the offer expertise and
dimensions of expected returns.
guidance to help you
• Diversify globally. focus on actions that
• Manage expenses, turnover, and add value. This can lead
taxes. to a better investment
• Stay disciplined through market dips
experience.
and swings.

Investing involves risks including possible loss of principal. International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Diversification does not eliminate the risk
of market loss. This is for informational purposes only and is not to be construed as investment or tax advice. Talk to your financial advisor prior to making an investment decision.

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 Ratio: Household Net Worth to Disposable Income
.

• The American consumer was in a good position prior to the Covid-19 outbreak as net worth and disposable income rates were at
all-time highs while savings rates remained elevated.

• Part of the issue in the global financial crisis of 2008 was that the average American household was overextended from a debt
standpoint which is fortunately not currently the case.
 Growth of $1 During Outbreaks

• Prior viral outbreaks have historically been a good buying opportunity.

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 Global Equity Markets Have Powered Through
Past Viral Outbreaks

• The markets have experienced 7 major viral outbreaks over the last 20 years with the last pandemic hitting in 2009.
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• Markets historically recovered quickly from these prior outbreaks however measures in place currently are much more dramatic.
 Average S&P Return of 30% from Peak to Trough
Around Recession
S&P 500 Performance Around US Recessions
Index Peak Index Months to Trough Peak to Trough 6m Return After
Trough Decline Trough
Jun-48 Jun-49 12 (21)% 23
Jun-53 Sep-53 8 (15) 18
Aug 56 Oct-57 15 (22) 10
Aug-59 Oct-60 15 (14) 25
Nov-68 May-70 18 (36) 21
Jan-73 Oct-74 21 (48) 30
Feb-80 Mar-80 1 (17) 31
Nov-80 Aug-82 21 (27) 42
Jul-90 Oct-90 3 (20) 29
Mar-00 Oct-02 31 (49) 12
Oct-07 Mar-09 17 (57) 50
Average 15 30% 26%
Median
15 22 25
Feb-20 Mar-20 1 (20)%

Source: Goldman Sachs Global Investment Research

• There is a very high probability that the U.S. economy will be thrust in to a recession due to Covid-19
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• The recovery in the 6 months after a market bottom surrounding recessions has been historically strong
 Change in production and consumption of liquid fuels

• Oil prices have fallen dramatically during the recent volatility however elements beyond economic uncertainty are manipulating
the oil market as Saudi Arabia and Russia are aggressively competing against each other in this space. 23