An opportunity to begin or reinforce a portfolio foundation amid the COVID-19 pandemic has been presented. COVID-19 was the back swan event that only comes along on the scale of decades. This COVID-19 induced sell-off has been the worst since the Great Depression in terms of breadth and velocity of the sell-off. This health crisis has crushed stocks and decimated entire industries such as airlines, casinos, travel, leisure, and retail with others in the crosshairs. The S&P 500, Nasdaq, and Dow Jones have shed approximately a third of their market capitalization, with the sell-offs coming in at 33%, 29%, and 36%, respectively, through March 20, 2020. Since then, stocks have attempted rallies. However, these have fallen short, and the lows are being retested. Some individual stocks have lost over 80% of their market capitalization. Investors have been presented with a unique opportunity to start buying broad market indices to lay the foundation of a portfolio or to reinforce long positions without single stock risks. Throughout this market sell-off, I have begun to take long positions in the broad market ETFs that mirror the S&P 500 ETF (SPY), Nasdaq (QQQ), and Dow Jones (DIA). It's important to put this black swan into perspective and see through this on a long term basis while viewing this as an opportunity that only comes along in decades.
Most Extreme and Rare Sell-Off Ever
Out of the 12 recessions that have occurred since May of 1937, the average sell-off for the S&P 500 was -31.6% with a range of -57% (2008 Financial Crisis) to -14% (1960-1961). The COVID-19 pandemic has crushed stocks beyond the average recession sell-off of -31.6%. The markets haven't reached the most severe sell-off levels by historical standards, so there's always a possibility for more downside potential. Regardless, at these levels putting cash to work would be prudent for any long-term minded investor.
The abrupt and drastic economic shutdown and velocity of the U.S. market's ~30% drop within a month brings parallels to the 1930s (Figure 1). This sell-off has been extreme and rare in its breadth, nearly evaporating entire market capitalizations of specific companies. The pace at which stocks have dropped from their peak just last month from all-time highs is the fastest in history. The major averages posted their worst week since the financial crisis in March. The Dow is tracking for its worst month since 1931, the S&P since 1940. As of March 20, the S&P 500, Nasdaq and Dow Jones have sold off 33%, 29%, and 36%, respectively. These broader indices remain suppressed and ripe for buying at these levels.
Figure 1 – Major market sell-offs and their corresponding peak-to-trough declines with the average sell-off coming in at -31.6%
Investors should look at this as a unique opportunity to invest in stocks and stay the course over the long term. Per Bank of America, looking at data going back to 1930, if an investor missed the S&P 500′s 10 best days in each decade, total returns would be just 91%, compared to the 14,962% return for investors who held steady throughout the ups and downs (Figure 2).
Figure 2 – Trying to time the market and potentially missing some of the best days can be detrimental to one's portfolio
The S&P 500 is currently at 2,490 or ~27% below its peak back on February 19. The index trades at ~14 times earnings for 2019. If next year recovers to the 2018-19 level again of $165 per share, the market is still at 14 times forward earnings, which is a discount to historic P/E multiples. The market traded at a P/E of 14.5 during the market meltdown in Q4 2018. Previous bottoms have seen lower P/Es in history with a P/E of 11 on March 9, 2009, the bottom during the financial crisis.
It's noteworthy to point out the Dow Jones' five worst single-day point drops, and the four best single-day point gains have all been in March. At a certain point, there will be an inflection point, and one of those big rallies will mark the turn in this market. If you sell now, you will be left on the sidelines, hurting your long-term returns per the data.
Per Bank of America, "the probability of losing money plummets to 0% over a 20-year time horizon." Time and again, bear markets have proven to be good buying opportunities. However, it can just take several years for the gains to be realized.
"Investors with longer-term investment horizons should remain invested in stocks," Goldman said, while Bank of America noted that "time is money for equities." The firm added that "for equity investors, the best recipe for loss avoidance is time: as time horizons lengthen, the probability of losing money in stocks has decreased."
Initiating Long Index Positions
The S&P 500, Dow Jones, and Nasdaq were off 33%, 36%, and 29%, respectively, from their highs. Out of the 12 recessions that have occurred since May of 1937, the average sell-off for the S&P 500 was -31.6% with a range of -57% (2008 Financial Crisis) to -14% (1960-1961). Throughout this stretch of market weakness, I started to buy long positions in these indices to reinforce the foundation of my portfolio and see beyond the COVID-19 health crisis. These names are well-positioned to explode higher when the market inevitably rebounds. These ETF positions have been purchased well off their highs, and I've averaged down throughout this sell-off. These were initiated too early in hindsight. However, I've scaled into these names over time with multiple purchases in small increments (Table 1). These broad-based positions will serve as a foundation when the market recovers, and I'll reinvest the dividends throughout the process.
Table 1 – Initiating long positions in small increments throughout the market sell-off to lock-in double-digit discounts from 52-week highs
Now is the time to lay down a foundation with broad-based ETF indices and/or reinforce your core portfolio holdings. After this epic sell-off, indices are too cheap to ignore, and starting to buy at these levels is prudent, especially if you'd like to avoid single stock risk. When you sell during a panic, you may miss the market's best days as rapid sell-offs often lead to quick bounces. COVID-19 has sent shock waves through the markets, causing double-digit declines across all major indices. Selling here has proven to put investors at risk for missing out on some of the best days ahead for the market. The COVID-19 induced sell-off has presented a great opportunity to take long positions in the broader indices such as the S&P 500 ETF (SPY), Nasdaq (QQQ), and Dow Jones (DIA). This can serve a great foundation for any portfolio as this type of decline comes few and far between.
Disclosure: The author holds shares in AAL, AAPL, AMC, AMZN, AXP, CMG, DIA, DIS, FB, GOOGL, GS, HQY, IBM, JPM, KSS, MA, MSFT, QQQ, SBUX, SLB, SPY, TRIP, UPS, USO and X. However, he may engage in options trading in any of the underlying securities. The author has no business relationship with any companies mentioned in this article. He is not a professional financial advisor or tax professional. This article reflects his own opinions. This article is not intended to be a recommendation to buy or sell any stock or ETF mentioned. Kiedrowski is an individual investor who analyzes investment strategies and disseminates analyses. Kiedrowski encourages all investors to conduct their own research and due diligence prior to investing. Please feel free to comment and provide feedback, the author values all responses. The author is the founder of www.stockoptionsdad.com where options are a bet on where stocks won’t go, not where they will. Where high probability options trading for consistent income and risk mitigation thrives in both bull and bear markets. For more engaging, short duration options based content, visit stockoptionsdad’s YouTube channel.