Unless you are a hermit living in a very remote cave, I’m sure you’re aware of the coronavirus pandemic.
And if you have any interest in investing, then you also probably know that stock markets around the globe have suffered what can only be described as a stock market crash.
Crash is a strong word, but with the FTSE 100 falling 26% (from 7,500 to 5,500) in less than a month it’s hard to call it anything else.
Technically speaking we are now in a bear market, which is somewhat arbitrarily defined as a decline of more than 20% from recent highs.
What does this mean for investors? Should we sell now and hide under a rock, or is there some alternative?
Before we do anything too hasty, let’s look at valuations.
As I write, the FTSE 100 is close to 5,500. That gives it a CAPE ratio (cyclically adjusted PE) of 11.3, well below its average value over the last 30 years of 18.4.
In fact, the FTSE 100’s CAPE ratio is now lower than at any time in the last 30 years, other than at the very bottom of the 2009 crash.
As for the FTSE 100’s dividend yield, it’s fractionally over 6%.
So with valuations at what I would conservatively call “cheap”, what should investors do?
Obviously I can’t tell you what to do, but I know what I’m going to do:
- I’m going to keep putting money into the stock market on a regular basis
- I’m going to keep looking for high yield, high quality stocks
- I’m going to keep focusing on where economies and businesses might be in five or ten years
- I’m going to keep ignoring day-to-day volatility
In short, I’m going to keep calm and carry on investing.
To some people that will sound crazy, but here are the assumptions I’m working under:
- Coronavirus has a mortality rate of less than 5%, so it isn’t going to be the end of the world.
- Within five years I think it’s likely that a) a reasonably successful vaccine will have been developed, approved and deployed, or b) the virus will be so commonplace that most people will have either had it and survived or will have just gotten used to living in a post-coronavirus world.
- Given the assumptions above, I think it’s likely that this particular coronavirus will have little impact on the global economy five years from now.
- If the economic impact is relatively short-lived (less than five years) then the impact on the long-term prospects of most good businesses will be minimal.
- If most economies and most good businesses are back to normal within a few years, then earnings and valuations are likely to be back to normal within a few years as well.
- If future earnings and valuations are approximately normal in say five years, then investing today at valuations that are well below normal is likely to produce above average returns over the medium to long-term.
If history tells us anything about this sort of thing, it is that the global economy has always bounced back from previous crises, including the Great Depression, World War II, the recessions of the 1970s, Black Monday in 1987, 9/11 and the dot-com crash and of course the recent Global Financial Crisis.
I’ll leave you with a few similar thoughts from someone much wiser than myself:
“During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.
Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”
– Warren Buffett, 2008
“Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%. But, surprise — none of these blockbuster events made the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices.
Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.”
– Warren Buffett, 1994
Hi John,
Thanks for the article. I think at this terrible time it reminds me of the importance of Warren Buffett’s circle of competence.
Having a through understand of your investment sector and business can act as a reassurance in the volatile market. Throughout this week I have asked myself the question how will this impact the businesses I have invested in. Most importantly will it affect the supply aspect and will demand change?
Hopefully if you sticked to areas you understand you can answer such questions and potentially it may mean a short term underperformance or not in some cases. Again this is very different to 2008 market crash which was driven by an overheated market this is as they now say a black swan event. Therefore we are operating in uncharted territory.
This moves me to dividends, as a DRIP investor this is actually beneficial because in theory it is likely to suppress share price for the medium time and allow me to accumulate more shares.
Are there many underpriced stocks? I’m struggling to find many but I think in the coming months it may lead some correction that are overdue. One thing I am glad is to have stayed away from oil stocks!
Hi Reg, I think there are a lot of very undervalued companies out there at the moment, but that wasn’t really the point of the article (although reading through it again it does look that way).
My point really was to provide a more positive longer-term viewpoint for investors who were worried, not only about coronavirus, but also about the plummeting (market) value of their retirement investments.
Having run this blog for more than a decade, I’ve seen people time and again sell their shares when fear grows and markets decline. I did exactly that during the dot-com crash and it cost me dearly, and so I hate to see other investors doing the same thing.
So yes, I think there are lots of undervalued high quality companies out there and market valuations in the UK are at generational lows, but my message is really to keep calm and carry on, rather than to buy the dip (although that’s an entirely sensible thing to do as well).
And from a human point of view, let’s hope the government’s plan for dealing with this pandemic is the right one.
Hi John,
Thanks for explaining the rationale of the article I agree with your sentiments. I hope more read this article to get a little perspective.
Selling now is not the best move. Today was a brutal day on my portfolio but as far as I can see the business that have invested remains unaffected. This has kept me calm because I think it gives me an opportunity to buy more stocks.
With regards to Coronavirus I do believe the response is slightly over exaggerated. Especially when you look at how the Chinese government has managed to slowdown its rate of affliction.
Oddly the response of the public concerning coronavirus seems very similar to how investors respond to bad news within the market. Majority of the time extremely disproportionate. My view is that this is due to having leaders who fail to inspire confidence.
Hi Reg, in terms of company-specific factors that can make a portfolio robust in the face of a major crisis, I would say these stand out as important:
Diversify by industry and geography.
Avoid company’s with lots of debts, which includes both borrowings and leases.
Invest in highly profitable companies (e.g. ROCE) as these tend to be stronger and more competitive, and therefore more able to withstand short-term shocks better than their weaker peers.
I don’t think there’s a silver bullet to this sort of thing and the market price of my portfolio is down by a lot (!). However, what I do know is that selling up and running for the hills is almost always the wrong thing to do.
Hi John,
“I did exactly that during the dot-com crash and it cost me dearly, and so I hate to see other investors doing the same thing. ”
Just wondered if you could expand on how this played out? I’m obviously not disputing you on the fact that it happened at all, personally, I just find it hard to imagine how you can get the timing wrong when it dropped 78% from the peak. Although, now that I think about it, I’m looking at it from the perspective of a long timeline and there’s various peaks throughout those years at which point someone might think it was trending back up again only to fall even more…
I suppose I’m mostly questioning it as it feels like there might be a lot further for the markets to fall in a short period of time in reaction to the coronavirus and so I’ve been thinking about withdrawing my investment based on this. Hopefully the recovery won’t take too many years as you estimate.
Thanks,
James
Hi James,
Back in 2003 I was a passive investor with 100% of my savings in a FTSE All-Share tracker. I knew nothing about the stock market other than the mantra that “in the long run stocks go up”.
I started investing in 1995 and had a fairy-tale first few years, with 20% gains or so every year. I didn’t keep up with market events at all and only read my six-monthly broker statements telling me how much my index tracker was worth. Other than that I had no interest in the stock market.
In 2000 the market was about flat, but in 2001 it fell about 15%, having tanked and then recovered from 9/11. I don’t think this decline bothered me and 9/11 and the impending wars were a much bigger concern.
In 2002 the markets fell another 25%, so by that point the full decline was about 40%. I think by that point my “stocks for the long run” viewpoint went out the window. I knew nothing about valuation multiples, dividend yields or fundamentals. All I knew was that the money I’d worked hard to save and invest was worth 40% less than it had been a few years before.
So like so many other investors, I sold everything and stayed in the “safety” of cash. I put a lot of it into premium bonds, which then sat there and did nothing for a few years.
Somewhere around 2005 or 2006 I realised that the markets had recovered, and that I’d missed out on the recovery by sitting in premium bonds.
That’s when I decided that I should probably learn a bit more about this investing lark. And the rest is history.
“it feels like there might be a lot further for the markets to fall in a short period of time in reaction to the coronavirus and so I’ve been thinking about withdrawing my investment based on this”
This was my key lesson from 2003. Nobody knows what the future will bring, and history suggests that the best course of action is to invest where valuations are most attractive. So 2003 was not scary and something to be feared, it was in fact a better time to invest than the peak in 2000 precisely because markets had fallen. And the same is likely to be true now. Today is probably a better time to invest than it was a month or two ago, precisely because valuations are so much lower and yields so much higher.
As for the timeframe, my estimate of five years is probably too long. Looking at the governments own epidemic timeline, the bulk of the disruption is likely to be over within a year.
Ultimately everyone has to make their own decisions, but as I said, my intention is to keep calm and carry on investing as normal, and that means investing money into the economy rather than taking it out.
Thanks for the detailed reply, it’s good reading an indepth personal viewpoint.
Thankyou for posting this John. Its investors like yourself that help me to stay focused and not make any silly moves. So I do appreciate your wisdom and I’m sure many other newer investors, if they have sense will listen to someone who’s made the mistake in the past and warns others not to do the same.
I’ve just not logged in to look at my portfolio to look at the temporary losses. After april when the isa re opens I’ve a bit of new money and there will be some dividens too to invest . So im calm and handling it ok .
Hi Dawn, thanks.
As they say, experience is the best teacher, but in this case it’s better to learn from someone else’s experience!
I read the comments in the Daily Telegraph investment section. There are some really doomsday investors there who naturally claim they went into cash Christmas time because they saw this coming and it will now be worse than the 1930s but smugly they will be fine (I fully expect the same people in a year or so to claim they bought back at the bottom). We are nowhere near as bad. For perspective the total decline in the 1930s was 86.1% over 34 months. The financial crisis in 2008 was 56.4% over 17 months. Black Monday 1987 was 33.1% over 3 months so 30% hardly a need to stock up on gold bars cans of beans and shotgun ammunition.
Rationally I would agree with you, but fear is a terrible thing and there’s a lot of fear around at the moment. For many people this feels like the end of the world, although I’m more concerned for people my parents age (70s) than myself (40s).
I’m sure it will be very unpleasant for many people, but eventually (perhaps within a year or so) this too shall pass.
Hi John
I’m not calm, I’m excited. For the investor (rather than the speculator) there is some excellent long term value in today’s market.
Cheers Keith
Hi Keith, as a value investor I agree, but I have to temper any enthusiasm with the knowledge that 2020 could be very rough in human and economic terms.
Eventually though, I’m sure that economies, companies, valuation multiples and life in general will all return to normal, and that’s something we can all look forward to.
Another great article, John. FTSE at a CAPE of 11. Incredible. Yielding 6%. Doubly incredible. Who need individual shares with THAT on offer?!
Yes it’s hard to make the case for stock picking when a low risk (in terms of dividend volatility and long-term value) index like the FTSE 100 is yielding 6%!
But if I look at my stock screen there are lots of very high quality businesses with dividend yields from 6% all the way up to 10%. I’m sure some of these will be cut this year, but longer-term these still seem to be very good businesses, so if ever there was a time for value investing to shine, the post-coronavirus recovery should be it.
John, I think it is important to mention that it would not yield 6% this year, as many dividends will be suspended.
We need to put things into the right perspective, this could be as worse as 1930.
Hi Eugen, you’re right, I think the FTSE 100’s dividend is likely to be cut this year.
However, any dividend cut is likely to be temporary, and given the relatively low CAPE ratio I still think market’s are attractively valued.
More importantly, for long-term investors I don’t think now is the time to sell.
Most FTSE 100s seem to have some cover for their dividends, so that’s a plus. As John has already pointed out, dividends seem in general to be less volatile than earnings, perhaps for that very reason. At current yields, we could have a 50% dividend cut and still only be back to the average kind of area where they’ve been historically. Once things pick up, of course your dividend yield is a function of what you paid, not the current market price…
It could be permanent if the company will go into administration or public ownership. Expect a few of those too, in the FTSE 100.
“It could be permanent if the company will go into administration or public ownership. Expect a few of those too, in the FTSE 100.”
That’s the thing about an index. You’re not buying individual stocks
Hi John,
I agree with your helpful suggestion but one thing I would say is essential is focusing on companies that have a high cash conversion and high profit margins. Companies that tend to record income on a accrual basis are likely to be most vulnerable and those with weak margin.
On a human level I agree it is a worrying time and like you I am concerned for my mother. However I was doing some more background reading on pandemics today and I think the UK government suggestion of slowing the spread and adopting herd immunity is probably the most suitable action plan.
Slowing the spread will allow the NHS and I am assuming the military to build up capacity to deal with the peak. Interestingly if the more healthy people get infected first and isolate themselves in theory it should reduce mortality rate and spread. As their immune system can fight it off readily whilst in the elderly it would just overwhelm people and increase the risk of transmission.
COVID-19 is a very serious issue, not because that it has a mortality rate of 1% to 2% (ten to twenty times higher than flu), but because it disturbs the economic activity so badly.
This is the sign of a bad recession. One for which printing money and tax cuts are not a solution. One for which we need a vaccine and fast.
I’d agree. Keeping 2 years of expenses in cash seems a prudent thing to do right now.
Hi John,
This time is different, REALLY different!
Things are changing rapidly!
Many businesses will fail but to rescue them, the governments will have no choice but let them still float on the exchange…
I warn you that the index can drop to negative territories just like the government yield!
This mean that investors/speculators will receive money when they buy a share~~
And when you sell a share, you will be debited the share price!
Dividends will be negative, meaning that shareholders will need to constantly pump cash into those biz to keep them afloat….
This is a whole new era which will be even worse than the Great Depression!
Past valuation does not matter anymore…..
Hi Johnny, that’s one interpretation but my guess (as that’s all it can be) is that this won’t be as bad as WWI or WWII or the Great Depression.
Let’s give it a year or two and then we’ll have a better idea.
This is the first I have ever heard of such a thing. Can you explain more?
Ladies & gentlemen, sorry for the confusion!
Above is just a bad joke!
As a believer on value investing (that is why we are reading John, right?), we understand market sentiment can swing wildly….
Remember the Warren Buffet’s preaching: “Price is what you pay and value is what you get”
With the current pace of falling for the index (ie -1000 points for DJIA), we will reach a bottom of zero in a month’s time. This is certainly not possible!
Yes, the ride ahead may be bumpy, just tighten your seat belt and it will be fine!
Hi Johnny, glad to hear it. I just assumed you were a tin-foil hatted nutter!
I think we have a very tough year or two ahead of us, but if world wars and previous pandemics (with far less medical technology) were not the end of the world, then this won’t be either.
Hi, John
Great article, as always from you. Thank you.
I came across this article today at the link below:
https://www.gurufocus.com/stock-market-valuations.php#
Do you have any thoughts for the UK market, considering the view in this article suggesting 1.6% annual growths in the US stock market based on TMC/GDP ratio as of today?
Hi Dilip,
The UK and US markets diverged on valuation terms a few years ago, with the US racing ahead into a major bull (bubble?) market and the UK remaining mostly where it was in the late 1990s.
My main valuation criteria is CAPE, and on a CAPE basis the UK is about as cheap as it’s been at any time in the last 30 years (FTSE 100 CAPE = 10 and FTSE 250 CAPE = 15). Of course, CAPE is based on 10yr average earnings and earnings in 2020 and 2021 are likely to be very significantly down on historic norms, but on a longer ten-year basis I still think the UK is likely to be quite cheap at the moment.
As for the US market, with the SP500 at 2400 it has a CAPE ratio of 21.7, by my calculation. The median over the last 35 years is 23, so it’s very slightly below that average. However, over the last 35 years the US market has been unusually expensive on several occasions, e.g. the dot-com bubble where it reached 42, the credit bubble where it reached 26 and the liquidity bubble (i.e. just before the coronavirus crash) where it reached 28.
Over the last 100yrs the SP500 average CAPE is about 17.5, so despite the world facing an enormous economic shockwave, the US market is still above its longer-term average valuation. So I agree with Guru Focus that the US is not yet cheap. But the UK probably is.
I intend to revisit UK and US valuations in more detail at some point in the next few weeks.
Hi, John
Thanks for your insightful reply. I appreciate it very much