March 2020
Obviously, as everyone knows, this has been a very volatile week. I am trying to think of another time where we have seen markets this volatile. The closest one that comes to mind is the fourth quarter of 2008, but even this eclipses it. This is unique in that the market is trying to wrap its arms around an issue that we really have not had to deal with which is, ‘exactly how much is this virus going to cost, not only in human lives, but in economic damage?’
I think the market over the last couple of weeks has been assuming that much of the American economy would go on as normal, but that there would be some changes. We knew some events would be canceled and that other travel plans would be canceled and re-booked for later. But, I think the market largely thought our daily lives probably wouldn’t change a whole lot. Last night, that really changed. Psychologically, it changed. So many organizations and entities canceled their events for the foreseeable future.
One thing that is different about this decline from the previous two declines that we have seen in the market, which were in 2000 and 2008, those two declines were caused largely by market miss-allocations of capital. In 2000, there was a lot of money chasing the ‘dot coms’ in the famous tech bubble. The market began to fall because of that miss-allocation of capital and a recession ensued because of the market decline.
That same thing happened in 2008, we had excessive leverage working its way through the financial system within banks and investment balance sheets. Once that leverage began to unwind, it caused the market to correct in a major way–falling 50% from the top [S&P 500 returns]. The decline then caused a recession in the economy.
This time, we don’t have the same kind of miss-allocations of capital where the market is causing the issue. This is truly a recession and implies that corporate earnings will fall. But the positive thing about this decline, is that we can estimate what those numbers should be.
The reason the market is this volatile is because we don’t know how long this is going to last and we don’t know how much the bottom lines are going to be affected but we can make some assumptions and determine maybe how far the market could fall beyond what it already has. This will likely be a temporary fall and not a permanently lower earnings number. It is not as though all future earnings at US companies should be discounted at a 25% rate today. As in previous health crises that we have seen, the market has corrected, there has been some amount of economic loss that occurs from that but there is a recovery and this is something that we expect.
As with other health crises, we will get through this. There will be a time where there is a recovery of both the economy and the earnings. So, logically the earnings should not be discounted permanently because of this.
A common question that comes about in times like this is ‘should we sell to avoid potential further losses?’ In times like this no one is sure of where the bottom might be. If you could save and potentially avoid additional losses, that seems like a valid strategy–to sell now and then by back at a later time when things look more attractive or they look more stable.
When others have looked at this and us as well, the window you have to time this correctly is fairly small. We are down about 25% [S&P 500 returns] in three weeks. It is not inconceivable that in a month or so when the market starts to feel better about things or whenever that might be, you might have a very small window of time from that market bottom to get back into stocks before they recover. It is this timing that is so difficult, and based on our numbers, we think an investor has to buy back into the market within 10 business days of the market bottom. This is a timing window that is too tight for most people to be able to hit and to be able to do consistently.
So, I think in times like this, the best advice is to review your asset allocation and make sure that it makes sense with your overall planning. We live on cashflows and those cashflows come from our investments. We have a certain timeframe and a certain amount of cashflows that we need to fund our standard of living. If that hasn’t changed, if those fundamentals of your personal planning haven’t changed, it is likely that no changes need to be made to the asset allocation.
We don’t want to rush in and sell assets that we believe are trading at $0.70 on the dollar today. If you are nearing retirement and you have planned the next 5-10 years of your life out and you know roughly how much you need and when, then there shouldn’t be any need to change your asset allocation. If something has changed with your estimates in terms of what you need, then that could justify a change. If you feel there are changes to your own circumstance, please talk with one of our wealth advisor’s today about it.
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