The first half of 2020 was one of the most volatile periods on record in stock markets. The crash and rapid recovery has contributed to what’s been an emotionally challenging time on many levels during the pandemic.
In the first weeks of the crisis, many people were worried about how bad things would get and whether the financial system would remain stable. Then, markets rallied, and relief took hold—things were going to be okay.
Now, I’m sensing from discussions with clients that we’re moving into a third phase of emotional reaction. Increasingly, I’m hearing people express concern about the sustainability of recent gains in stock markets. They’re worried we may have come too far, too fast, and might be slated for another crash.
Besides concerns about the rapid rise in stock prices, I’ve also fielded questions recently about the enormous amount of debt being accumulated by governments to finance aid packages. Will it end up sinking the economy and the stock market?
As I explained in my mid-year review, U.S. government gross debt as a percentage of GDP was at a similar high levels after the Second World War. Yet, the U.S. stock market increased strongly through the late 40s, 50s and 60s. It was the same story after the 2008-09 financial crisis when the stock market performed well despite sharply higher levels of public debt. These two historical episodes suggest there is no correlation between government debt and stock market performance.
As we’ve seen, there are solid reasons why markets have recovered from the pandemic sell-off. Does it mean they will continue to rise or will correct sharply after such a big run-up? We simply have no way of knowing. A large body of research has shown no one can consistently forecast market movements.
However, what we can learn from the volatility of the recent months is the importance of sticking with a broadly diversified portfolio that reflects your tolerance for risk.
A well-designed financial plan allows you to leave the worrying to the market gurus and be secure in the knowledge that despite short-term bumps you are positioned to benefit from market returns to build wealth over the long term.