Binary stock market 401k crash

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Brett Arends’s ROI

Brett Arends

It’s a golden chance for a portfolio do-over

Don’t sweat the crash, use it

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If you’re among those kicking yourself for not having the foresight to sell all of your stocks a month ago, don’t.

Instead, congratulate yourself on your wisdom and foresight for hanging on.

That is not because of the monster rally of the past few days, which has clawed back just a small portion of the trillions lost.

It’s because while your stock portfolio may be down, many other investments, which you could usefully buy, are down even further. And that means you suddenly have a golden opportunity to redo your portfolio, broaden your risks and improve your diversification. And you’re better off doing it today than you would have been last month.

Consider: If you’re like most regular U.S. investors, you have most or even all of your stock market investments tied to just one index: The S&P 500 SPY, +0.46% , which tracks the 500 biggest companies in America.

It’s the biggest index in the world, and the one that most mutual funds follow when they offer a plain vanilla “U.S. stock market fund.”

In the past month the S&P 500—even counting the latest rally—has fallen 17%.

But during the same period of time, U.S. small-company stocks, as measured by the Standard & Poor’s 600 Small Company Index SML, +1.31% , have fallen 26%. So if you transfer some money today from your S&P 500 fund such as the SPDR S&P 500 SPY, +0.46% to a U.S. small cap fund, such as the SPDR S&P 600 SLY, +1.34% , you’ll actually get a much better deal than you would have done a month ago.

And it’s the same for almost everything else. Real-estate investment trusts or REITs, both in the U.S. and overseas, have fallen by much further than the S&P 500. So you’ll get more, say, Vanguard Real Estate VNQ, -0.39% and Vanguard Global ex-U.S. Real Estate VNQI, -0.83% than you would have done in February. “International” funds, which invest in the MSCI EAFE index 990300, +0.41% of developed overseas markets of Europe, Australasia and the far East, and “emerging markets” funds that invest in places like China, South Africa and Brazil, are all much cheaper than they were a month ago. U.S. investors switching their money into funds such as iShares Core MSCI EAFE ETF IEFA, +0.15% , SPDR Portfolio Emerging Markets ETF SPEM, -1.31% and Vanguard FTSE All World ex U.S. Small Cap VSS, +0.29% are getting a comparative bargain.

They’ve all fallen by more than the S&P 500. In most cases, by a lot more. So the portfolio do-over is actually a better deal now than it was in February. You just got a discount.

If you want to look at individual markets overseas—and it’s not necessary—the scale of the crash is hard to fathom. Since 1988, for example, the economy of Taiwan has quadrupled. But this week the Taiwanese stock market went back to the levels it was at when Ronald Reagan was U.S. president.

The Japanese and Italian stock market indexes this week also fell back to 1980s levels. Germany’s fell to the late 1990s. South Korea and Australia were back to the mid-2000s.

Those who think investments other than the S&P 500 are “too risky” or are best left to professionals have it exactly upside down. The bigger risk is tying all your retirement portfolio to a single index.

Sure, the S&P 500 has been the place to be during some decades, such as the 1990s or the one just past. But during other 10 year stretches the index has been dead money, or worse.

The S&P 500 lost ground from 2000 to 2009. Meanwhile U.S. small-caps rose 85% and Emerging Markets more than doubled. During the 1970s the main U.S. stock index failed to keep up with runaway inflation. But the emerging Asian “tigers” of the era boomed: Japan went up 400% and Hong Kong 800% — really—during the decade. Even during the boom of the 1980s, you were better off investing in Europe and Japan than you were in big U.S. companies.

All of which suggests that when you held on to your big S&P 500 index fund last month you were being wiser than you thought—assuming you want to take advantage of an opportunity to diversify.

Brett Arends’s ROI

Brett Arends

7 lessons for managing your retirement accounts in this — or any other — erratic market

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1. You really can’t time the market and shouldn’t try. Those who panicked and cashed out just missed a massive, 10% single day jump. And this happens in every crash. Dalbar, a financial analysis company, calculates that ordinary investors have on average missed out on most of the stock market’s long term gains over the past 30 or more years. “One major reason that investor returns are considerably lower than index returns has been the fact that many investors withdraw their investments during periods of market crises,” it wrote in a research paper sent to clients in November. “Since 1984, approximately 70% of this underperformance occurred during only 10 key periods. All these massive withdrawals took place after a severe market decline.”

2. History may be repeating itself. Historically the biggest stock market jumps have come after giant plunges. The giant crash of Oct. 19, 1987 was followed by a 10% surge in the Dow (DJIA) on Oct. 21. The worst two days of the famous Wall Street Crash of 1929, on Oct. 28 and Oct. 29, were followed by a massive 12% surge in the Dow on Oct. 30 — the market’s third best day ever in percentage terms. The 10% plunge on March 12 of this month was followed by a 10% rocket on March 13.

3. Watch out for history repeating itself still more. Historically, the biggest one-day stock market jumps have also taken place during bear markets where the stock market then resumed falling again. Since 1900, 14 of the stock market’s 20 best days have been during bear markets, where prices kept falling.

4. A major reason for the stock market’s bounce is almost certainly technical. Hedge funds and other speculators had been making big money on the way down by borrowing stock they didn’t own, selling it in the market, and getting ready to buy it back later at cheaper prices. Such so-called “short selling,” which is perfectly legal, makes money when stock prices fall. However, it leaves speculators vulnerable to a sharp jump in prices. When that happens, they rush to buy back stock and close their positions. That causes a further jump in prices, though it may be short term.

5. The rally doesn’t mean good news for the economy just yet. When that happens we’re likely to see a slump in the price of so-called “safe haven” assets, such as Treasury bonds, Treasury inflation-protected securities, also known as TIPS, and gold. Instead, Treasury and TIPS prices barely moved on Tuesday from their brace-for-impact levels, and gold jumped 10%. Treasury bonds are offering interest rates of less than 1% for another 10 years. At current levels the stock and bond markets are still forecasting prolonged economic slumps.

6. Your broker is probably reminding you about now that if you miss out on the stock market’s biggest one-day jumps you will miss out on a big chunk of your long-term returns.And that’s true. But it’s only half the story. Avoiding the worst one day crashes — such as the carnage so far this month — is also about as good for your wealth as catching the big one-day rallies. Bottom line? The worst possible outcome is to chase these rallies after they’ve taken place. You can easily end up catching the crashes and missing the bounces. That’s how you lose your shirt. Buy and hold investors, of course, can just ignore the turmoil. But those who are on the sidelines need a disciplined approach to reinvesting. One simple rule that anyone can use, and which has significant academic support, is to compare the S&P 500 SPX, +0.39% with its average price for the last 10 months, or 200 days. Get out of the stock market when the S&P 500 falls below the 200-day moving average, and stay out until it gets back above it again. One study has shown that just following this rule would have spared you all the terrible stock market crashes of the past century without sacrificing much in long-term returns. Note: Even after Tuesday’s surge, the S&P 500 would have to rise another 28%, to 3044, to reach the 200-day moving average. That would mean roughly 27,000 on the Dow DJIA, +0.25% .

How Does the 2020 Stock Market Crash Compare With Others?

Latest Dow declines among worst in terms of point, percentage drops

The stock market crash of 2020 began on Monday, March 9, with history’s largest point plunge for the Dow Jones Industrial Average (DJIA) up to that date.   It was followed by two more record-setting point drops on March 12 and March 16. The stock market crash included the three worst point drops in U.S. history.

The drop was caused by unbridled global fears about the spread of the coronavirus, oil price drops, and looming recession. Only two other dates in U.S. history had more unsettling one-day percentage falls. They were Black Monday on Oct. 19, 1987, with a 22.61% drop, and Dec. 12, 1914, with a 23.52% fall. 

Although this dramatic 2020 market crash is still fresh in everyone’s mind, let’s take a closer look at what happened and why. That will allow us to anticipate what may happen next with the economy.

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Fall From Record High

The 2020 stock market crash began on Monday, March 9. The Dow fell 2,013.76 points that day to 23,851.02.   It had fallen 7.79%. What some labeled as Black Monday 2020 was, at that time, the Dow’s worst single-day point drop in U.S. market history.

On March 12, 2020, the Dow fell a record 2,352.60 points to close at 21,200.62. It was a 9.99% drop, almost a correction in a single day. It was the sixth-worst percentage drop in history. 

On March 16, the Dow hit a new record. It lost 2,997.10 points to close at 20,188.52. That day’s point plummet and 12.93% freefall topped the original October 1929 Black Monday slide of 12.82% for one session.

Prior to the 2020 crash, the Dow had just reached its record high of 29,551.42 on Feb. 12. From that peak to the March 9 low, the DJIA lost 5,700.40 points, or 19.3%. It had narrowly avoided the 20% decline that would have signaled the start of a bear market.

On March 11, the Dow closed at 23,553.22, down 20.3% from the Feb. 12 high. That launched a bear market and ended the 11-year bull market that started in March 2009.

The chart below ranks the 10 biggest one-day losses in DJIA history.

Compare to Previous Black Mondays

Before March 16, one previous Black Monday had a worse percentage drop. The Dow fell 22.61% on Black Monday Oct. 19, 1987.   It lost 508 points that day, closing at 1,738.74. On Black Monday Oct. 28, 1929, the average plunged 12.82%. It lost 38.33 points to close at 260.64. It was part of the four-day loss in the stock market crash of 1929 that started the Great Depression.

Causes of the 2020 Crash

The 2020 crash eventually occurred because investors were worried about the impact of the COVID-19 coronavirus pandemic. COVID-19’s mortality rate so far is more deadly than the seasonal flu’s rate, but that’s because many more cases of the flu are reported annually. Although less deadly than SARS’s death rate in 2003, COVID-19 is spreading more quickly. On March 11, the World Health Organization (WHO) declared the disease a pandemic.   The organization was concerned that government leaders weren’t doing enough to stop the rapidly spreading virus.

The stresses that led to the 2020 crash had been building for a long time.

Investors had been jittery ever since President Donald Trump launched trade wars with China and other countries. By Feb. 27, the Dow had skidded more than 10% from its Feb. 12 record high. It first entered a correction when it closed at 25,766.64.

Effects

Often, a stock market crash causes a recession. That’s even more likely when it’s combined with a pandemic and an inverted yield curve.

An inverted yield curve is an abnormal situation where the return, or yield, on a short-term Treasury bill is higher than the Treasury 10-year note. It only occurs when near-term risk is greater than in the distant future.

Usually, investors don’t need much return to keep their money tied up just for short periods of time. They require more to keep it tied up for longer. But when the yield curve inverts, it means investors require more return in the short term than the long term.

On March 9, investors demanded a higher yield for the one-month Treasury bill than the 10-year note.   Specifically, the yield curve was:

  • 0.57% on the one-month Treasury bill
  • 0.33% on the three-month bill
  • 0.38% on the two-year Treasury note
  • 0.54% on the 10-year note
  • 0.99% on the 30-year Treasury bond

Investors were telling the world with this market signal that they were so worried about the impact of the coronavirus over the next month that they needed a higher return on the one-month bill than for the 10-year note.

Inverted yield curves often predict a recession. The curve inverted before the recessions of 2008, 2001, 1991, and 1981.

In addition, bond yields across the board were at historically low levels. Investors who sold stocks in the crash were buying bonds. Demand for bonds was so high that it drove down yields to record-low levels.

How It Affects You

If you have retirement savings or other funds invested in the stock market, the crash lowered the value of your holdings. When something like this happens, many people panic and sell their stocks to avoid losing more. But the risk with that strategy is that it’s difficult to know when to re-enter the market and buy again. As a result, you could lose more in the long run, if you miss important market gains in the shorter term. On average, bear markets last 22 months. But some have been as short as three months. Most financial planners recommend you sit tight and wait it out.

Strong demand for U.S. Treasurys lowered yields. Interest rates for all long-term, fixed-interest loans follow the yield on the 10-year Treasury note. As a result, interest rates on auto, school, and home loans should also drop to record-low levels. Keep in mind that, even if 10-year Treasury yields fell to zero, mortgage interest rates would be a few points higher. Lenders must cover their processing costs.

In a surprise move on March 15, 2020, the Federal Reserve cut its benchmark interest rate a full percentage point to zero. It also launched a bond-buying program, referred to as quantitative easing, to mitigate the expected damage to the U.S. economy from the coronavirus.

Is a Recession Next?

The bad news is that the combination of a stock market crash and an inverted yield curve can signal a looming recession. A pandemic often slows economic growth, as businesses slow or close and people stay home to nurse their illness or avoid catching it. These factors could easily trigger a recession.

So it makes sense to add to your savings now, if possible, to make sure you have three to six months of living expenses on hand. If you have enough cash on hand, then buying stocks isn’t a bad idea, because prices are low. The driving forces behind the stock market crash of 2020 are unprecedented, but strategies to survive such crashes and recessions have been proven to work throughout history.

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