On monday, the S&P 500 index of U.S. stocks fell almost 3%. Since July 29, it has dropped almost 6%. Over that time, European and Japanese stock markets went down by similar amounts. The Canadian market also fell, though by a bit less. The main reason for the poor performance over the last week or so is fear that the global economy is heading south. Among other things, there is worry that trade disputes, especially the one between the U.S. and China, could trigger a recession. This was highlighted by the reaction to the threat by U.S. President Donald Trump to hit China with more tariffs. With these alarming headlines, you might wonder if it’s a good idea to invest in stocks or sell most, if not all, of your stock positions and stay in relatively safe bonds or cash instead.
Before making such a move, however, it is important to consider some aspects of historical stock movements. On one hand, the markets are right to be afraid the possibility of recession in the economy. The U.S. stock market lost over 50% of its value from October 2007 to March 2009 during the Global Financial Crisis. On average, the stock market loses about 30% around the time of a recession. Economic downturns are usually preceded by painful falls in stock markets. Therefore, it would be reasonable to view the recent drawdown as a signal to run for the hills. However, sharp falls in equity prices aren’t always followed by economic downturns. When stock markets go down without a recession, these falls are shallower and don’t last as long. For instance, the S&P 500 fell by almost 14% in the last 3 months of 2018 while the S&P/TSX index of Canadian stocks shed 10%. But despite the threat of trade wars, both markets soared by over 16% each at the start of 2019. The S&P 500 was up by 10% for the 1-year period ending in June 2019… which includes that sharp decline at the end of last year. Similar sequences happened in 2011 and 2015. If you had taken money out of the market then or waited on the sidelines to invest some more, you would’ve likely missed out on the rebounds that followed. Stock market corrections, where the markets go down significantly and quickly only to snap back up, are somewhat frequent, at least once every 2 years by some estimates. True “bear markets” accompanied with an economic downturn are much scarier but also don’t happen as often. The trouble is that these are hard to see in advance. Economic data such as employment and industrial production are still positive in the U.S. for now, indicating that the global economy (which still mostly depends on the U.S. economy) will stay afloat and the stock market will not crash yet. It is entirely possible that these trade wars or other factors do sink the economy eventually but that just hasn’t happened yet. Until then, all that can be done is to accept that the markets will remain volatile and, if your investments are right for you, stay the course. Make sure, however, that these are appropriate for you and speak with your advisor if you have one.