It is becoming clear that the coronavirus outbreak may be more difficult to contain than initially hoped. And the economic toll, as health officials curtail transport and close factories and stores, could remain unclear for weeks. But if you have a smart investment plan, you should be able to pull it off, despite volatile days like Monday.
Here’s what you need to know.
Why the market reacts
This is not the first time the US stock market has reacted to coronavirus fears, with some industries such as airlines and hotels already showing weakness. Meanwhile, the Chinese stock market has been hit even harder, with stocks falling as much as 10% in late January, although they have since regained much of the lost ground.
Still, US investors, cradled by low unemployment and strong corporate earnings, had largely ignored the fears – until now. One of the reasons is Apple, one of the most valuable and watched companies in the market. Apple last week said it would no longer meet its quarterly revenue target after the coronavirus reduced its ability to make iPhones in China and also hurt sales of its products to Chinese consumers.
Another reason investors are suddenly paying attention is the apparent spread of the virus beyond China, particularly in Europe. While isolated cases have emerged in the United States and elsewhere for weeks, the recent increase in several countries suggests authorities are struggling to contain the virus.
Moreover, the fact that it appears to be settling in Europe could mean greater disruption for the US economy. Overall, US large-cap stocks made about 38% of their total income from foreign markets in 2018, according to Morningstar. While around 8% were from China, around 14% were from Europe.
Why you shouldn’t overreact
While Monday’s stock market decline is the biggest of the year so far, dominating the headlines on many news sites, you need to consider it in context.
The Dow Jones remains at 27,961. While it’s nearly 4% below what it was on Friday – a shocking drop in a few hours of trading – it’s just a bit below where the market at the beginning of the month. The Dow Jones started in February at 28,256. Go back a little further and the market looks even better. It was not until November 16 that the Dow Jones closed above 28,000 for the first time in its history. Indeed, even taking into account Monday’s sharp drop, investors are still up around 8% over the past 12 months.
Another thing you need to keep in mind is that while the market can react quickly to bad news or economic uncertainty, these reactions can be short lived. Earlier this month, Dow Jones Market Data looked at how the market has responded over the medium term to previous health scares over the past 40 years, such as SARS in 2003.
The potential economic effects of the coronavirus are frequently compared to SARS, and the market has finally brushed aside those concerns. Large-cap stocks rose about 14% six months after the first outbreak of the SARS epidemic and 21% a year later. The data tells roughly the same story for most of the dozens of health issues examined by Dow Jones.
What to do now
So what should you do in response to Monday’s Global Sale? The answer, as always, is probably nothing. Your investment horizon should be long term. If you have money in the stock market, that means at least five or 10 years, if not decades, for the savings hidden in a 401 (k) or IRA. This should leave enough time for your holdings to recover, even as transportation and supply chain disruptions trigger a significant economic downturn in parts of the world.
That said, you shouldn’t necessarily be complacent either. If Monday’s big drop is giving you a cold sweat, you may want to consider reducing your exposure to the stock market and adding bonds. (A target date fund like the ones we recommend in our Money 50 list of the best mutual funds can help you find a mix that’s right for your age.)
Just because the coronavirus is not likely to send the stock market into a spiral. But rather because, with stocks still close to record highs – and very high valuations as well – you can assume that sooner or later the market is going to take a big drop. If you think you could really panic if the market goes down 10 or 20%, it’s better to take a small haircut today than a bigger one in the middle of a real bear market.
You have less time to recover from missteps if you are about to retire or have just retired. Locking in large market losses in your first few years of retirement, just as you start to dip into your savings to fund your living expenses, can dramatically reduce the income potential of your portfolio in the years to come. Some experts advise you to fund your essential expenses through guaranteed income sources such as Social Security and a regular fixed income annuity, so that you don’t have to touch your stock portfolio for a while if the market collapses.
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