2020 was, without a doubt, a year unlike any other. Very rarely does something happen that completely alters the behavioral patterns in society. There is still much to be unfolded from the Covid crisis, but what we do know is that there will be a lot of differences between the post Covid world and pre Covid world. There are two way to analyze what happened. You can conclude that everything that happened was entirely random, with no discernible lessons to be had, or you can view everything as a having some sort of meaning behind it that fits into the grand scheme of things. I am choosing to go with the latter here, as I believe within the context of history there is much to be learned with how events unfolded in the past and in how we can view things going forward. Specifically, here are some of the market lessons I have taken away from 2020.
1.) The economy and the stock market can be very disconnected at times. One thing that was surprising about 2020 was that many economists’ projections for how the pandemic would play out were actually pretty accurate. Some of the specific numbers may have been off, but the general themes – work from home, online shopping, accelerated tech dependency, reduced economic capacity until a vaccine is widespread – have all been pretty spot on. On the other hand, I don’t think I saw any stock market projections that were even close to what actually happened. When you think about it, it makes sense. Who could possibly believe the S&P 500 would be up more than 18% in a year when the economy is in a lockdown? These types of disconnects happen a lot throughout market history. They happen both ways. For example, during the tech bubble nothing special was happening with the economy, but the stock market, the NASDAQ composite in particular, soared from 1994 to 2000 until it crashed and returned back to a more normal level. An example of the opposite side would be the 1987 crash. The 1987 crash was the largest single day market plunge in history. This was a time when the economy was as strong as ever and there really was no reason for the market to crash. Ultimately, the stock market is very forward looking and isn’t as concerned with shorter term blips, but there are always a lot of reasons that explain why the market and the economy become disconnected. The main takeaway is that this is a very normal state for the stock market to be in. Over time, the stock market will follow along the same trajectory as the economy, but there are a lot of factors specific to the stock market, such as interest rate changes and stock buybacks, that will move the stock market one way but won’t have a material impact on the economy.
2.) The stock market is always the same – it’s always changing. During a relatively uneventful time period it’s possible to get deceived into thinking that much of what happens is very repetitive, but a year like 2020 with big changes reminds us that the market is always evolving and changing. One example is the rise in retail investing volume. Typically institutions make up the majority of trading volume. Institutional trading is usually much less volatile because it is based around actuarial guidelines and investment mandates. In 2020 we had historically high volatility. This is of course largely attributed to the coronavirus, but it can also be attributed to a large rise in retail investor trading volume. Retail investor volume was up significantly in 2020. While not necessarily a bad thing, this does make markets much more unpredictable. Retail investors do not follow any actuarial guidelines or have risk restrictions or have any of the other restrictions that institutional traders have. This is just one of many things that can change significantly at any point in time and have a material impact on how the market behaves. 2020 emphasized that adaptability is a key trait for any successful investor to have.
This article will be continued in part 2.
