Your Money or Your Life?


counting money

Written by Kevin Kern

“Your money or your life?” is the crystal clear offer that muggers will give their victims to minimize a scuffle.  Those in their right minds will hand over their wallet and spare their lives.  The markets, economy, and investors are getting mugged right now by COVID-19.  Though tempting to hold onto on your wallet it’s time to concentrate on you.   The markets and your money will heal.  But it will be up to you whether mentally you can recover as an investor and keep yourself healthy throughout this ordeal. Home isolation, 24-hour news cycles and the fear of health issues can have even the most sensible investors making questionable decisions.

A Possible Scenario for Investors

Over the past couple of weeks, we have been telling clients that it will have to get worse before it can get better.  Well, here we go.   The social media jokes and jabs have turned to real fear.  Celebrities, athletes, and politicians have contracted or have been exposed to the Coronavirus.  Events, sports leagues, and gatherings are being shut down.  The stock and bond markets have become dysfunctional and central banks and our government has moved in to provide much-needed liquidity and support.  Welcome to the first phase of this ordeal.

Phase two will be uglier.  The number of people infected will shock most Americans as testing begins.  We will begin to know someone who has contracted the virus or has been exposed.  As the number increases more and more restrictions will be required for the self-quarantined. Businesses will begin to feel the pain but particularly small business and their employees will have a heavy load to bear.  The call for robust fiscal policy will get louder and the markets will continue to be volatile.  This is the phase investors will find most difficult; to stay invested.  But this phase is the necessary means for long-term financial recovery.

The Pig in the Python

Phase three will be all about monitoring the “pig in the python”.  Nothing is more important for recovery than the successful containment and eventual reduction of new U.S. infections. This virus has a history of infections and recoveries in China, South Korea and other parts of the world.  Both China and South Korea have worked hard to slow the rate of infections to a trickle.  Like a swallowed pig moving through a python we can track the rate of infections and see the dramatic drop off in China and South Korea.  The virus (or the pig) is moving through these two countries (nearing the end of the python).  The same will be true for each country in its path. Recoveries in China and South Korea are now outpacing new infections.  China’s stock market is nearly back to pre-crisis levels and its people are going back to work.  Supply chains are opening up again.

At some point during phase three after potentially thousands of infections in the U.S. our financial markets will see that U.S. infected recoveries on a percentage basis have begun to outpace new infections. The number of people infected will still be alarming but the improving percentages will be welcoming to investors.  At this point, a well-greased market with low rates, Fed driven liquidity, and powerful fiscal policy will move much faster toward recovery than the cash-rich faint of heart will be able to anticipate.  This is why we stay invested.

What Is My Portfolio Manager Doing?

Our investment team has been actively reviewing each holding and sector to make sure we can take advantage of what will be an inevitable recovery.  ACM ‘s investment discipline is growth (or income) at a reasonable price.  As a GARP manager, we will use this opportunity to look for securities that might have been too expensive before the correction.  We are also reviewing for companies that could present better recovery possibilities than current holdings. As importantly our portfolios prior to the correction were cheaper in valuation compared to the S&P 500 on a price to earnings basis.   In the early stages of any sell-off, even great inexpensive stocks get sold.  Passive investing in ETFs make it very easy for “the baby to get thrown out with the bathwater” but good inexpensive companies traditionally become very attractive as markets recover and investors want to get back to sensible investing.  Be assured any excess cash our managers have will also at some point be deployed based on economic outlook and closely tracking infection recovery rates. This does not mean that our clients need to do the same with their additional cash.

What’s an Investor to Do?

It would not be prudent to take money from your cash reserves and make a plan to allocate more into stocks for a potential upswing.  Cash reserves are designed to be large enough so you can let your stocks act like stocks and not have to worry about day to day volatility. Adding more reserve money to a stock allocation may present an unpleasant situation forcing you to liquidate shares in a down market.  Markets don’t go straight up.  It’s impossible to pick a bottom and your cash needs may not coincide with a jagged recovery.

Depending on your risk tolerance, age, and total assets it is normally not recommended to change your stock to bond allocation at this point in the correction.  Shifting to bonds will only retard your eventual recovery.  In addition, liquidity in the bond market has been excessively poor in these volatile weeks given the massive market moves.  The bid (where you can sell) and ask (where you can buy) spreads are tremendously wide. Bond sellers are likely to get hurt as buyers are demanding a deal to provide such liquidity. Allocating more to stocks may heighten your market anxiety.  Investors will have a lot of time at home to question themselves and their fortitude.   I urge clients to be smart, and not cute when it comes to rearranging your investment allocations.

Why Many Investors Fail

And finally, since markets don’t recover in a straight line, clients may be tempted to raise cash as news and their personal lives become more complicated.  When investors leave the market for safety they have completed only one of two difficult decisions that need to be timed with precision.  While investors who have left markets feel better, getting reinvested is where most will stumble. There will not be an invitation in the mail when “the coast is clear”.  The difficulty of timing these decisions is evident in how well investors have fared over the past 20 years* versus different asset classes.

Source: Dalbar Inc.  JP Morgan Asset Management.  Indices used are as follows: REITS: NAREIT Equity REIT Index, EAFE: MSCI EAFE, Oil: WTI Index, Bonds: Bloomberg Barclays U.S. Aggregate Index, Homes: the median sale price of existing single-family homes, Gold: USD/troy oz., Inflation: CPI. 60/40: A balanced portfolio with 60% invested in the S&P 500 Index and 40% invested in high-quality U.S. fixed income, represented by the Bloomberg Barclays U.S. Aggregate Index. The portfolio is rebalanced annually. Average asset allocation investor return is based on an analysis by Dalbar Inc., which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20 year period ending 12/31/18* to match Dalbar’s most recent analysis.  Guide to the Markets U.S. Data is as of December 31, 2019.

Over the past two decades through 2018, the average investor had earned an annualized return of 1.9% while the S&P 500 has achieved 5.6%.  During this period inflation averaged 2.2%.  Along with trying to time the market for safety, investors have also contributed to this unpleasant return by not taking or maintaining their appropriate risk.  Particularly after market corrections.

Can this market go lower? Yes. Until we can measure infection recovery success the bottom may not have been reached. It is also unclear how long and hard this event will weigh on the economy.  Clients must make sure that they have the right amount of cash for expenses so that liquidating stocks is not a temptation.  If this downturn is prolonged those clients who have the option to reduce their monthly distributions to dividends and interest only should consider preserving principal.

As always, our advisors and portfolio managers are available.  Please call us if you need any support.  Stay safe and be smart.


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