The Major Lesson From a Wild, Tumultuous Year in Markets

With two trading days left in the year, the S&P 500 is up 17.5% year to date.^[i] The MSCI World Index is right on its heels at 15.5%.^[ii] If you were locked in a sound-proof chamber devoid of any interaction, online or otherwise, with the outside world all year and got only this information, you might think 2020 was just a nice, ordinary, modestly above-average year. Obviously, it wasn’t. February and March saw history’s fastest bear market, turning the year into a wild rollercoaster most would rather forget (not to mention the pandemic, natural disasters, social upheaval, a contentious election and all the other events this year threw at us). To those who hung on through the tumult to capture the rebound and subsequent gains, whether intentionally or because terror froze you into inactivity, never forget how your patience paid off—that lesson will serve you well the next time stocks encounter such sharp volatility. To those who missed some of this year’s returns, take heart: One year won’t make or break anyone’s long-term returns. For everyone out there, success doesn’t depend on how you did in 2020 alone. But what you have learned this year could be vital to future success.

There are plenty of lessons to learn from this year—and plenty of other articles listing them out. So here we will just offer a simple one: If you are investing in stocks for long-term growth, there are generally only two valid reasons to exit the market. First, if sentiment is so rollickingly euphoric that investors’ expectations have become almost comically high and impossible for reality to beat in any realistic universe. Second, if you see something big, bad and unnoticed—something no one else thinks could wipe a few trillion dollars or more off of global GDP. Those are the two things that generally cause bear markets, and identifying them early on can help you see a bear market just after it begins, giving you plenty of time to get out before the worst hits.

When stocks peaked in mid-to-late February, euphoria was absent. The COVID lockdown fell into the second category, which we call a wallop, and stocks started pricing those lockdowns’ economic fallout in weeks before they became official. Markets bottomed on March 23, the very day the UK became the last major nation to enter lockdown—and the day before IHS Markit’s flash purchasing managers’ indexes for March offered the first look at how much lockdowns were harming global economic output.

Usually, stocks take several months to descend from their peak to -20%, meeting the technical definition of a bear market. This time, it took just weeks. The decline’s speed left many shell shocked, and when you are shell shocked, you generally don’t trade. As a result, at least from our vantage point and study of personal finance commentary across the Internets, many people were still invested when the bear market hit its trough. That, quite obviously, was very painful for many. But it also meant an unusually high number of people were fully invested when the recovery began, enabling them to capture it as long as they kept hanging on.

Said hanging on is one of the most difficult things an investor could do this year. Stocks rallied hard those first several weeks after the bear market’s low, but the world around us felt anything but good. Headlines warned the rally was false, propped up artificially by central banks and government largesse. Economic data were historically awful. Two-week lockdowns suddenly turned indefinite. Tens of millions of people were out of work. Shops and cafes’ temporary closures were increasingly becoming permanent. Every day, another round of investment commentary warned the world stocks were overlooking all of this damage, and once they opened their eyes and saw how bad things were, the second shoe would drop. Get out while you can was the general theme.

This is when the two-pronged bear market identification rule served investors best, in our view—and that is the crucial takeaway for this year. Yes, the lockdowns were lingering and bringing obvious economic consequences. But they were also very widely discussed at that point, which we think was a very strong indication they had lost their negative surprise power over markets. We were all living through the consequences of lockdowns in the spring and early summer, but stocks had dealt with them in February and March. Markets were forward-looking on the way down and forward-looking on the way up. The circumstances surrounding each bear market change, but stocks’ nature doesn’t.

In our view, this is what investors need to internalize. Volatility is a regularity in stocks. There will be corrections, which are generally as fast and sharp as this year’s bear market but not fundamentally driven or as deep (usually -10% to -20% or so). There will also be more bear markets. Ideally, it will be possible to identify them early enough to mitigate some of their declines. But volatility, corrections and bear markets frequently present choices and temptations to get out at the wrong time—after stocks have fallen a lot. So if you held the course this year, examine your rationale critically: Was it skill and well-reasoned decision making, or was it a passive decision—or sheer luck? Just because you made the right decision doesn’t mean you have nothing to learn. If it was coincidence or luck, then admit it to yourself, be thankful, and then take heed of how markets work for next time. And if you didn’t stay the course and missed some of the rally? Take heed of those very same lessons, then remember your long-term goals and time horizon, and take heart knowing success comes from accruing market-like returns over that entire period. If you can take the lessons you learned this year and apply them over the next 10, 20, 30 or more, it could be very beneficial in the end, with much to be thankful for along the way.