This has certainly been a year that the investment community will not soon forget. Unprecedented volatility caused by coronavirus disease 2019 (COVID-19) pandemic initially cost widespread S&P 500 (SNPINDEX: ^ GSPC) more than a third of its value in the first quarter. Amazingly, the steepest move in the bear market in history was followed by one of the fiercest rallies on record. In 12 days, when 2020 ends, it will be likely that the S&P 500 will earn above-average annual earnings.
The question is: can the for-profit party continue in 2021?
On the one hand, there are catalysts that could propel the market higher. President-elect Joe Biden, who will be sworn in on January 20, has pledged to fight for additional tax incentives. Meanwhile, the Federal Reserve expects to keep lending rates at or near historic lows until at least 2023. The US economy will be supported in a variety of ways, which would likely be conducive to further stock growth.
On the other hand, history suggests that we have problems.
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Expect another volatile year in 2021
Over the past 71 years, the S&P 500 benchmark has undergone 38 stock corrections of at least 10%. Nine of these smaller moves have led to a bear market (a loss of 20% or more). On average, we see a good faith correction every 1.87 years, with lower market movements, from 5% to 9.9%, with an even higher frequency.
Moreover, in each of the eight previous bear markets (excluding the COVID-19 bear market), there was an aggregate of 13 locks or corrections of at least 10% within three years of reaching the bottom. This means that the typical scrap in a bear market has one or two often sudden collapses in the stock market of up to 19.9%.
Apart from history, other factors could play a role in weakening actions in 2021. For example, COVID-19 vaccines are fully expected to help the US and the world out of this pandemic. But there is no guarantee that clinical trials, regulatory approvals, production, distribution and vaccinations will go according to plan. At this time, we do not even know how many people are willing to receive the vaccine in the United States or how long these potential vaccines will provide protection.
Financial action, which is the backbone of the US economy, could also fight over additional state-level blockages or perhaps closures imposed by the federal government. Banks have done a good overall job of canceling reserves for loan losses so far, but there could be a dramatic increase in loan delinquencies in 2021.
The point is that stock market crashes are an inevitable part of the investment cycle, and investors should be prepared for the worst of 2021.
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The worst moves you can make if the stock market is busy
Of course, there are clever ways to navigate a stock market crisis and a trio of moves that are the worst things you can do. If the market collapses in 2021, avoid falling into these traps.
1. Weak panic selling in the short term
The first major mistake to avoid would be the panicked sale of one or more shares, as the short-term momentum increases in a negative way.
Although stock market blockages and corrections are unpredictable, a fairly well-known thing is that downside movements in the market do not last very long. Of the 38 stock market corrections mentioned above since the beginning of 1950, 24 lasted between 13 and 104 calendar days (approximately 2 weeks to 3.5 months). In comparison, bull markets are almost always measured in years, as opposed to weeks or months.
Moreover, blockages and corrections are unlikely to have any influence on your investment thesis in a company. If you were to take a step back and evaluate your initial reasons for buying a stock, you would see that a short-term accident or correction rarely, if ever, changes that sentence.
In short, avoid running to the exit when volatility increases.
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2. Using margin to buy shares
Second, you will want to avoid using a margin such as the plague.
Even though history has shown many times that high quality companies tend to grow in value over time, it is impossible to predict short-term movements in the market. While buying on margin can increase your gains, it can also make up for your losses if you guess wrong in the short term.
To make matters worse, using the margin means borrowing money from your broker with interest. Although the rate you will borrow may vary, you will pay anywhere from the average 1% to the high 7% when you borrow margin from an online broker. The interest you will owe is just an added pain if you make a wrong move in the short term.
Except for short selling, which should only be undertaken by permanent investors with an understanding of the risks involved, the margin should not be used.
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3. We wait for the market to decline before buying shares
The third and final action to avoid is waiting too long to buy shares during a correction.
Speaking from experience, I can say that it is perfectly normal to want the best possible purchase price when buying a share in a public company. Unfortunately, we will never know in advance when an accident will occur, how long it will last and how steep the movement will be. This makes it impossible for investors to accurately time their bottom market purchases. I know I missed a lot of great companies, because I thought they would drop another 2%, 5% or 10%, just to see them lose my purchase price and jump over 100% +.
In addition, about half of the S&P 500’s best days in 20 years have occurred in the weeks since the worst one-session declines. If you decide not to buy on the big days of the market, there is a good chance that you will lose the inevitable rebound.