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Guidance in Uncharted Waters
Dealing with a situation we have never faced before
With markets and the economy reeling from COVID-19 (the coronavirus), stocks have just finished their worst quarter since 2008. If the professional and personal stress of our world wasn’t enough for you, consider the unprecedented volatility investors experienced during the quarter from Feb 17th to March 23rd; the S&P 500 Index fell 34% for the fastest loss in history. On the other hand, the following three days (March 24th-26th) saw the market gain 17.5% for the best three-day stretch since the 1930s.
We are dealing with a situation we have never faced before. The near-term economic damage from the coronavirus outbreak will be severe. GDP is expected to sharply contract, potentially by historic proportions, and unemployment is rising to levels never seen before. Without any analogous history available as a guide, we must consider two general scenarios: the positive case and the negative case.
The Positive Case: The early countries that contracted the disease have shown good progress and has brought the disease under control relatively quickly. Unprecedented aid by central bankers and world governments help the economy survive in the short term. The economic damage is severe but brief, with a snap back recovery driven by pent up demand once things return to some normalcy.
The Negative Case: The outlook for the disease is still very uncertain, and headlines are likely to continue to get more frightening in the coming weeks. The economy will retract at a severe rate, and the return to “normal” economic activity will prove to be slow and challenging. Many industries and companies face dual issues: too much debt and decimated revenue and may never return to their previous level of earnings.
Where we end up is most likely to be, as always, somewhere in the middle. We can’t know for sure, so we must rely on a time-tested approach to stay disciplined, always recognizing when emotion rears its head in investment decision making. If we invest based on emotion, we are very likely to exit the market after it has already dropped meaningfully, locking in losses. By the time the discomfort and worry are gone, the market will already be much higher. Our disciplined approach has worked in other downturns and it should work again. We believe it is the true recipe for long-term investment success.
Remember that, as we stated in our Investing in Scary Markets letter, in times like these we need to pause and remember what goals we set out to achieve when we started investing. If you are drawing retirement income from your portfolio, you will still get your monthly check. If you are saving for your future, your recent contributions were used to buy stocks on discount. If your goals have not changed, you should not have to drastically change your portfolio. The best advice is to stay the course and we understand this is not easy.
The future is uncertain, but our investment process remains the same: diversify; rebalance; balance long-term returns with short-term risks; buy low into fear, sell high into greed. Following the sharp decline in March, we have added a modest amount of stock investments to most client portfolios from proceeds in fixed income investments which had risen.
We continue to hold cash ready and assess the point at which we’d further increase our exposure to equities, however given the quick rise in stocks at the end of March we have increased the margin of safety we want to see before doing so. We also are taking advantage of any tax-loss harvesting opportunities, helping to offset any taxes you will have to pay on future gains.
While the news may sound dark and hopeless at times, remember that this too shall pass. The world has faced many challenges and economic downturns and has always come out the other side. What matters most – for both our health and our finances – is how we act along the way.