Sudden portfolio changes can lead to bad and costly investment decisions

Sharp falls in global sharemarkets this month – and a daily barrage of headlines about the coronavirus threat – are unnerving for retail investors. As uncertainty about the virus runs high, some investors could make rash decisions and damage their wealth.

Every investor is different and it pays to do extra research or consult with a licensed financial adviser before making sudden changes to your portfolio. Fear is a powerful investing emotion and history shows it has caused many investors to sell at the worst time, crystallising loses.

That is not meant to downplay the seriousness of coronavirus (COVID-19) or the possibility of further falls in global and Australia sharemarkets in coming weeks or months. At March 10, COVID-19 cases worldwide had surpassed 110,000, according to the World Health Organisation (WHO), and were gaining momentum in Europe and the United States.

Some commentators have likened COVID-19 – in terms of its impact on global sharemarkets – to the 2008-09 global financial crisis. Such comparisons are simplistic and talk of “another GFC” could promote investors to make bad decisions, fearing the worst.

The GFC was a financial-market shock that weighed on the global economy for years as consumers reduced spending and demand suffered. The COVID-19 crisis is a global economic shock that is hurting financial markets. Its effects are for now more on the supply side: factories in China shutting down and less access to raw materials and export markets, for example.

Unlike the GFC, the COVID-19 crisis is unlikely to weigh on the global economy for years. Optimists first thought the economy would snap back in a V-shaped pattern as the crisis passes, global supply chains are restored and as consumers resume normal activities. However, it is too soon to know and a drawn out U-shaped recovery from the crisis is likelier.

Also true is that government and central bank responses to the financial impacts of COVID-19 are challenging. Unlike the GFC, central banks cutting interest rates – as happened in Australia and the United States in March – may have less effect. Goverment spending initiatives via fiscal policy will be needed – and are coming in Australia and the United States - but they take time to work through the real economy.

The bottomline is: it is too early to know how this global health crisis will play out or whether sharemarkets will fall further, punctuated by so-called ‘relief rallies’ There is a good chance higher sharemarket volatility could persist for some time until financial markets become confident the worst of the virus has passed.

Calm approach needed

Five things, however, are clear. The first is that relying on a daily diet of COVID-19 headlines to make decisions is dangerous for long-term investors. There is a risk that some news stories spread misinformation or have overly alarmist headlines to lure readers.

Second, context is needed. The S&P/ASX 200 index fell about 17 per cent from its all-time high in mid-February 2020 to 5,936 points on March 10, largely due to COVID-19 fears. The ASX 200 index rose 7 per cent in early 2020 and 20 per cent over 2019 (the total return is higher when dividends are included). It is not unusual for sharemarkets to have periodic corrections (10 per cent or more) after such strong rallies, painful as those losses are on paper.

Third, crises eventually pass. The average length of drawdown in global sharemarkets from disease outbreaks is 35 days, according to Credit Suisse research in early March. It is impossible to know if that average will be broadly true for COVID-19, but there were signs in early March that China’s health initiatives were starting to slow the spread there.

Much work is underway to develop a vaccine, more than half of those who contracted COVID-19 have since fully recovered and the estimated mortality rate (of cases) from the virus was 3.4 per cent on March 3, according to WHO data.

Fourth, history shows sharemarkets bounce back quickly from disease-related crises. Australian shares rose 26 per cent in the year after the market low from the 2003 Severe Acute Respiratory Syndrome (SARS) outbreak, according to Macquarie Equities research published in early March.

Macquarie says the coronavirus is worse that SARS, but expects a “similar (market) playbook”. It suspects growth in US cases will peak within weeks, in line with China’s experience, and ASX stocks will rebound with US stocks, unless COVID-19 cases rise rapidly here. Technology was the best sector in the year after the SARS-related market low, notes Macquarie.

Fifth, history shows that sudden portfolio asset reallocations (tilts) after big market falls – such as switching completely from shares to cash – can damage portfolio returns for years. The risk is that investors lock-in losses after the damage is done and miss out on higher returns from a possible sharemarket recovery.

As AMP Chief Economist Dr Shane Oliver wrote in early March: “Selling shares or switching to a more conservative investment strategy or superannuation option after a major fall just locks in a loss. With all the talk of billions being wiped off the sharemarket, it may be tempting to sell. But this just turns a paper loss into a real loss with no hope of recovering.

“The best way to guard against making a decision to sell on the basis of emotion after a sharp fall in markets is to adopt a well-thought-out, long-term strategy and stick to it.”

Famed investors such as Warren Buffett have, over the years, bought more shares during market corrections and taken advantage of panic selling to buy at lower prices. Some investors might go bargain hunting in this correction or active investors and traders could look to capitalise on market volality – perhaps by trading ASX-quoted exchange-traded funds (ETFs) over key local and international sharemarket indices. That is their decision to make.

None of this commentary should be read as advice to whether to buy or sell shares during this correction, or as a prediction of how COVID-19 will play out. Nor should it understate the significance of COVID-19 as a humanitarian tragedy or a ‘Black Swan’ market event, or the potential for elevated market volatility to persist for some time, or a global recession

Rather, the story’s intention is to highlight the importance of long-term investing and riding out market storms.

History shows that “averaging” into the sharemarket over time can build long-term wealth. And that making sudden investment decisions based on the latest social media headline – when market uncertainty and fear is rampant – has a higher chance of destroying wealth.