Global concerns heightened this week as Iran, Italy, Japan, South Korea and other countries have seen an increase in the number of new cases of the coronavirus. Uncertainty about the coronavirus and its containment and treatment have caused concern around the world with headlines using words like “outbreak,” “pandemic” and “emergency.” Questions about economic growth and health and public safety have caused governments, corporations and individuals to feel unsettled as they search for solutions and answers.
These concerns have injected volatility into the global financial markets this week. From February 19 through February 27, the S&P 500 Index fell 12.03% and the Russell 3000 Index fell 11.98%, entering correction territory. A correction is defined as a drop of 10 percent or more in stock prices from its most recent high. The CBOE Volatility Index (VIX), which is a gauge of the U.S. equity market’s expectation of future volatility, rose to 39.16 on February 27.
This level of volatility has been reached before. The VIX rose to 36.07 in December 2018 on trade concerns with China and reached a similar level in February 2018 due to threats of inflation. The VIX reached 40.74 on August 24, 2015 with the Brexit vote. To provide some perspective, the S&P 500 is up 26.70% from December 24, 2018, 12.45% from February 5, 2018 and 57.34% from August 24, 2015 (through February 27). These periods of elevated volatility likely derived from short-term fear and uncertainty in the global financial markets similar to what we are seeing now.
Regarding market volatility, David Booth, executive chairman and founder of Dimensional Fund Advisors, said: “Times like this can be difficult, especially since we don’t know how long they will last. But try not to lose sight of your long-term goals, and remember that uncertainty is actually part of what creates opportunity. Equities have higher expected returns than other investments because they require investors to bear additional risk. Without uncertainty, investors wouldn’t get paid for taking on this risk.”1
When stocks do poorly and bonds do well, portfolios become overweight bonds and underweight stocks, leading to rebalancing opportunities. Rebalancing allows an investor to put money into stocks at lower levels (higher future expected returns on stocks). This behavior leads to greater long-term wealth. Rebalancing takes money from those asset classes that have performed well (bonds this year) and uses that increased purchasing power to buy asset classes that have become cheaper (stocks currently). Thus, we actually want to be selling bonds and buying more stocks.
We are reminded that volatility in the financial markets is considered normal and something we expect to experience. Stock prices will fluctuate but volatility associated with the coronavirus should not stipulate a change in course.