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THIS MONTH MARKS the five-year anniversary of the start of the pandemic. That makes this a good time to look back and ask what lessons we might learn.
In early 2020, when COVID-19 was first identified in the U.S., the stock market dropped 34% in the space of just five weeks. But later in the year—after the Federal Reserve stepped in with its bazooka—the market rebounded, ending the year in positive territory. For full-year 2020, the S&P 500 actually rose 18%. Most remarkably, from the low point in late March to the end of the year, shares gained 70%. This provided a unique opportunity for investors who had the fortitude to rebalance their portfolios and buy stocks when things looked bleakest.
But that, of course, is easier said than done. During times of crisis—when the market presents what should be attractive buying opportunities—several factors conspire against us. It’s worth understanding these dynamics so we can recognize them the next time a crisis rolls around.
The first dynamic is what you might call the Mark Twain effect. An aphorism attributed to Twain is that history doesn’t repeat, but it does rhyme, and that certainly applies to the stock market. When it comes to market downturns, historically they’ve all ended the same way—with the market recovering and eventually going higher. But that’s the easy part. Where they’ve differed—and where they probably always will differ—is in their origins.
In the 1970s, it was an oil embargo. It 2000, it was the bursting of the technology bubble followed by the attacks on 9/11. In 2008, it was the failure of Lehman Brothers. In 2022, it was inflation.
Because each crisis is so different, no one can be sure how bad it will get or how long it will last. And because of that, each one feels uniquely terrifying. That’s typically what causes markets to drop suddenly at the start of a crisis. But unfortunately, that only compounds the atmosphere of panic.
Because of this panic, logical thinking tends to get tossed aside. That’s the second dynamic we see during crises. Back in 2020, I suggested a thought experiment to help combat this. The idea was to imagine an unrealistically extreme scenario and then to calculate the effect on the stock market. This requires just a simple three-step process.
The first, for simplicity, is to choose a single company for this analysis. Next, make the extreme assumption that the company might lose an entire year of profit as a result of the crisis. Finally, use a valuation technique known as discounted cash flow to calculate how that lost year of profit should—strictly according to the numbers—affect the company’s stock price. The premise of discounted cash flow is that it assumes a company should be worth the sum of all of its future cash flows, adjusted for inflation.
For this exercise in 2020, the company I chose was Procter & Gamble, which makes things like soap and shampoo. Let’s revisit how the numbers would have looked to an investor at the start of the pandemic.
At the time, P&G was worth about $300 billion and was earning about $10 billion a year. Therefore, to assess the impact of losing an entire year of earnings, we would simply subtract $10 billion from P&G’s market value. The result: P&G shares should have been worth just 3% less. After all, $10 billion is 3% of $300 billion. But because of the panic and the absence of logical thinking, P&G’s shares fell more than 20% in the early days of the pandemic.
Of course, some companies will always fare better than others during a panic, so you might repeat this exercise using other representative companies. The key conclusion would likely be the same, though: Stocks almost always drop to irrationally low levels during crises because panic replaces logic. But as the P&G example illustrates, market downturns usually represent buying opportunities—not based on faith but on the numbers.
Why does logic go out the window when crises occur? One cause is the din of storytellers. Especially during crises, market commentators go into overdrive. And since it’s anyone’s guess how things will turn out, they’re free to paint whatever picture they wish. You might wonder, though, why anyone would listen to them. We all know no one has a crystal ball.
Psychologist Steven Pinker offers an explanation. For evolutionary reasons, he says, our minds have learned that to survive, we must always be looking to make sense of the world around us. In fact, for survival, it’s critical to understand cause and effect in our environment. But that’s a problem, Pinker says, because sometimes this part of our brain gets carried away, telling stories and drawing conclusions even when they’re completely made up. The mind, he says, becomes a “baloney generator.”
Unfortunately, the media contributes to this phenomenon. Look at a financial news site, and you’ll notice that many of the headlines are presented in this format: “Market Rises as Inflation Fears Cool.” At first glance, this might seem like a perfectly reasonable statement.
The problem, though, is the word “as,” which implies a cause-and-effect link where one may not exist. I call that a problem because, on any given day, innumerable variables combine to drive the market in one direction or another. Headlines like this, however, lead investors to believe that these relationships are simple, scientific and predictable when they’re not.
Economic experts also contribute to this problem. In April 2020, the managing director of the International Monetary Fund referred to the pandemic as “humanity’s darkest hour.” Around the same time, a well-known hedge fund manager commented on TV that “hell is coming.” To be sure, the pandemic was terrible, but hyperbole like this, in my view, only contributes to the sense of panic.
The pandemic is—thankfully—in the rearview mirror, but we’ll face other crises in the future, and they’ll probably arrive just as COVID did: entirely out of left field. That’s why it can be helpful at a time like this, when markets are strong, to be sure your finances are prepared for whatever might come next.
Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles.
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As my wife says, it doesn’t matter what the price is until it’s time to sell.
A reminder as to why I no longer hold individual stocks as trying to figure out the risk profile of each holding can get tedious. Its also worth remembering that things can deteriorate gradually and then suddenly, leaving little time to take corrective action. This was certainly true during the dot-com crash as many stock were losing all of their value in a single day. Personally, I’ve already raised a bit of cash to meet my expected RMD’s for the next 2 years. A change in asset allocation to reduce US market risk may also make sense. In the end, however, every investor needs to have decided on what their maximum pain point might be before they would make more substantial changes.
Hey Adam, thanks for taking over the editor duties for Jonathan. I’ve always found your writing to be insightful.
Not all of the market is frothy, so small and mid caps are reasonable. Switch your large cap to Buffer ETFs like PGIM funds that provide 12 or 20 % down side protection.
I completely agree with the media statements that imply, or outright say, a cause and effect between a news item and the results of an individual stock or even the whole market that day. Part of the problem is the statement that “investors reacted today by…….” whatever action — buy or sell. Those aren’t investors — those are day trading gamblers. I am old enough to remember watching Lou Rukeyser on PBS’s Wall $treet Week every Friday evening. One-half hour of commentary was enough, in addition to reading the WSJ daily. Now we have CNBC, Fox Business, Bloomberg, and maybe others calling in some experts and some people we have never heard of, giving their learned opinions about what happened today or what will happen tomorrow.
I miss the pandemic. Except for the fear of catching Covid and dying, I loved the quieter times and the non existent traffic.
Turn off the news and the Internet. That is a good start. If our portfolios are at our targets, we should be fine.
This is easier said than done because bear markets are at their scariest right before the rally. It is hard to stay put, let alone start investing again.
I enjoyed this article. The “market” of course is people, and people tend to overreact, so position your portfolio accordingly.
The problem with the market now is that valuations are so stretched prices would drop 25-35% if they just return to long-term averages for dividend yields, P/E, P/B, P/S, etc. A crisis will be the catalyst but the underlying reason for a big drop might just be that trees never grow to the sky.
Goo analysis. Another dynamic I’ve observed is the post-crisis Monday morning quarterbacking.. many of us seem to forget the fear, confusion and chaos as the crisis unfolds. Afterwards we know exactly what the issues were and what steps should have been taken. I’ve seen this play out on the corporate level when complicated, aggressive projects inevitably went sideways. The inside joke was that there was never anybody available to help, but plenty of folks afterwards to assign blame.
As the saying goes, “Victory has a thousand fathers, but defeat is an orphan”.
Quick research shows most attribute this to JFK after the Bay of Pigs fiasco, but is disputed.
I’ll let Jonathan perform the in depth research on the origin as I know it is a favorite pastime of his.
It looks like a version of the quote may have originated with the Roman historian and politician Tacitus:
https://www.goodreads.com/quotes/8699367-this-is-an-unfair-thing-about-war-victory-is-claimed
Great article. It seems to me like the competition among journalists to get published add to the problem of exaggerated headlines and inaccurate stories. George H W Bush commented in his diary that the writer who presented himself as an expert in one area last week, suddenly presented himself as an expert in a different area the following week. They remind me of my friend Bubba down at the local watering hole; a lecturer on everything and an expert in none.
Marjorie dispenses some wisdom below; think for yourself and don’t follow the hoards.
Adam, A very sensible overview of what happens, not only in markets, but in all aspects of life. Making sense of the world around us does mean retreating from the din of the experts and sometimes poisonous media.
Too often, we are intimidated by those who consider themselves experts. As Mr. Pinker noted, our brains get carried away, even when the stories are completely made up. Worse, we even try to foist these falsehoods on others.
Regardless of my limited knowledge, I have seldom subordinated myself to experts. I will listen and then form my own conclusions; . Based on how my situation fits into the larger picture—my goals, my dreams and my aspirations.
It might seem easy to follow the experts’ advice, but then what do you do when two different experts, both of whom you respect, give conflicting advice? Your last paragraph gives a great answer.
I spent my career in healthcare. As the pandemic was unfolding I was surprised at the number of folks who said, “Don’t believe the experts, do your own research.”
I know people that did their own research and got very sick.