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Coronavirus Confirmation Bias

Did you sell stocks before the crash? I didn’t, but I know that there were many investors who sold stocks and saved significant sums of capital as the coronavirus events played out. Some sold select stocks because they anticipated the long term impact that the coronavirus could have on many industries, many of which would, in conjunction with high debt loads, bring these companies to their knees. To these investors, I applaud you. If you sold the likes of Carnival (CCL) before it was forced to dilute shareholders – you have my deep respects.

However, there were also many investors who knew that stocks would be worth more in the long term yet sold stocks anyways because they also “knew” that stocks would keep going down in the short term. Perhaps these investors also began thinking that tracking coronavirus case numbers was an actual bearish investment strategy. To these investors, here is my message: I am worried for you. I am worried that this successful experience with market timing may lead you to miss out on the ride of a lifetime. Confirmation bias is the human error which occurs when a person has a hypothesis which is proven true and assumes that their logic was correct primarily due to the correct result.

My fear is that the latter investors who sold stocks and moved into cash, moving forward, will think that their decision to sell was correct. My fear is that many investors will from now on refuse to hold stocks through bull markets to make that 9-10% annual returns, because they instead want to just hold cash and wait for another 50% crash. History shows that this is a big mistake, as more likely than not, when the next “catastrophic” event comes around, it’ll prove to be a short term blip but these investors would still be in cash when the market has already roared higher. It is easy to forget, but since the 2000’s alone, there have been many potentially catastrophic events which proved to be simply near term blips – the coronavirus should not be mistaken to be a common occurrence. It is far too easy to become “that investor” who holds far too much cash or sells stocks every time there’s a big event with big negative headlines.

Why You Should Believe In The Long Term

There’s a saying that goes: if you missed the top 10 days from the past 20 years, your total investment returns would drop in half. This brings attention to an important reality: while many people focus on how quickly stocks can fall, many forget how quickly the ensuing rebounds typically are. I now focus on several of the market downturns in the past two decades, many of which I suspect readers have forgotten about or at the very least, forgot the fear in the markets during that time.

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No one can forget the terrorist attack on September 11, 2001. With fears of a new World War, the stock market sold off over 10% in the next trading session alone. The sentiment was extremely pessimistic as the market appeared to be adjusting for life during a World War. Would war negatively impact global stability and global trade? Did such fears lead to further declines in the stock market? No! Stocks recovered back to the pre-selloff levels over the very next few days:

(Yahoo Finance)

In June 2015, the stock markets fell suddenly as the world reacted to the Greece financial crisis. The markets recovered briefly before plunging around 10% as China reported weak GDP numbers for the first time in many years, leading to a selloff in Chinese stocks and worries of the negative impact that a slowdown in Chinese growth would have on global markets. We have an event that had the potential to send ripples across the global markets – did the stocks crumble? No! The dip would prove to have a V-shaped recovery as stocks climbed back almost as fast as they fell:

(Yahoo Finance)

In June of the same year, “Brexit” finally was taken seriously by the rest of the world when a parliament vote showed that it may actually come to fruition. Brexit threatened to destabilize the European Union, which would “inevitably” destabilize the global economy. What happened? Another V-shaped recovery:

(Yahoo Finance)

Finally, a recent event that many may have already forgotten about: the US-China trade war. When it became clear that there would be no quick resolution to the trade war, stocks dropped around 15%. The trade war was clearly already a global impact and slowing down economies across the globe. What happened? A V-shaped recovery:

(Yahoo Finance)

We have seen a common trend: all of the discussed events led to V-shaped recoveries. V-shaped recoveries are particularly dangerous for market timers because of the risk that investors sell at the bottom waiting for further declines, and never buying back in as the market roars back to bull mode. The reasoning for all of the recoveries made sense: the long term trajectory has never been impaired because stocks represent ownership of real earnings in real businesses. The earnings made by the underlying companies every year along with some growth is enough to lead to respectable annual returns and enormous long term returns. A warning: hindsight is 20-20, but that only applies to the realization that stocks came back. Hindsight isn’t likely useful in helping one remember just how pessimistic and grave the dangers appeared at the time. It’s easy to say that the next big event “is different” when you don’t remember the feeling from previous big events.

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Do Stocks “Typically” Drop 50%?

The last point that I want to bring up is my message to those who think that “stocks always crash in cycles.” I can’t blame those who think that – if one has been investing through the 2000-2001, 2008-2009, and now the coronavirus crashes, you’d think that the stock market has huge crashes (~50%) every 8-10 years. In reality, that’s only true if you look at the previous 20 years. In the century ending 2000, there was only one huge crash, that being the Great Depression.

So now I’ve debunked the theory that stocks “usually” crash 50%. Now I want to finally debunk the investment strategy of holding large sums of cash waiting for that 20-30% decline.

We already know that most of the time, you will make money in the stock market long term. What if I told you that even if you were the most unlucky investor for some of the absolute worst stock market crashes in history, you would have still made a ton of money?

What was the total returns if someone bought the S&P500 (SPY) at the top of the 2000-2001 stock market bubble and held until January 2020? Assuming dividends were reinvested, they would have made 6.2% annually, or 220% total. Again I should emphasize – that’s the return if someone bought at the very top of the 2000 stock market.

What was the total returns if someone bought the S&P500 at the top of the market in 2007 right before the 2008-2009 Great Financial Crisis and held until January 2020? Assuming dividends were reinvested, they would have made 8.5% annually or 175% total.

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What we can conclude from the above findings is that: most of the time you’ll make money in stocks and even if you are the most unlucky investor in the world, you still end up making serious cash over the long term. Assuming 7% long term returns, a retirement portfolio would return 16 times your original investment over 40 years. I never understood how someone could chase unlikely 20-30% market downturns in light of the 1600% long term potential returns.

What will be the returns over the next decades for someone who bought at the top right before the coronavirus crash? It is obviously too early to tell, but my hunch is that it’ll be more than satisfactory for most.

Conclusion

To those who made money selling stocks indiscriminately or even shorting stocks into the coronavirus crash, I’m worried for you. I’m worried that you’ll forget that the stock market has survived countless big events and that most of the time, the market recovers very quickly. History has overwhelmingly favored investors who are “too dumb” to time the market and prefer to just buy and hold. It’s up to you to make your choice: do you want to chase an unlikely 20-30% discount to invest in a likely 1,600% long term return?

The Market Is Pricey – Be Choosy

The broader stock market has recovered. The average stock is expensive, but deeply undervalued opportunities of high quality companies still exist. The coronavirus has brought extreme pessimism, and with it, the opportunity of a lifetime.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: DISCLAIMER: Julian Lin is not a Registered Investment Advisor or Financial Planner. While the information in his articles and his comments on SeekingAlpha.com or elsewhere may seem like financial advice, it is not, and it is provided for information purposes only. Do your own research or seek the advice of a qualified professional. You are responsible for your own investment decisions.