Over the past decade, the S&P 500 is up 250% (it’s closer to 400% if you include dividends). As impressive as the bull market has been, the relatively muted volatility, to me, has been the most impressive part. The reason it’s been so amazing was outlined succinctly by Tony Dwyer, Chief Market Strategist at Canaccord Genuity. He wrote that “in the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless’. What I can say is that a month ago, most people thought the macro outlook was uniformly favorable, and they had trouble thinking of a possible negative catalyst with a serious likelihood of materializing. And now the unimaginable catalyst is here and terrifying.”
Embracing the unknown and realizing that we won’t be able to pick the bottom is the first step, but regardless of the size of the decline, our playbook remains the same:
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- Extreme downside inevitably leads to a reflexive reaction to the upside due the market fear leading all investors to being on the same side of the boat. Given the vast amounts of negative news, there is an asymmetric risk/reward for good news, although we don’t know in what form this will take. In February 2016, it was something as simple as a vote of confidence from the CEO of one of the largest banks in the world, Jamie Dimon (known in the financial world as the Dimon bottom). In November of 2008, it was Warren Buffett making a large investment in Bank of America to give America the confidence to do the same (even though the market didn’t bottom until March of 2009). What will it be this year? We will only know in retrospect.
- The reflexive rally will likely only go high enough to burn off the fearful/oversold condition, not to repair the entire damage. Per our blog post on March 9th, we continue to expect a reflexive rally to lessen the fear in the marketplace. We anticipate this rally to be in the magnitude of 10%-15%. For reference, a 10% rally will take us back to around 3000 on the S&P 500. The idea that this will be a “V-shaped recovery”, similar to Q4 2018, is unlikely in my opinion. During that period of time, the market was reacting to one specific issue, interest rates. Once Federal Reserve chair Jay Powell did a 180 degree about face in December of 2018, the market did the same. The current crisis will be filled with uncertainty for some time. When will we start to see the number of Coronavirus cases in the United States peak, and inevitably subside? When will Americans have the confidence to freely move about the country and the rest of the world? How will these events affect the numbers of corporate America, and in turn, the economy overall? Will the “work from home” contingencies lead to a future transformation for corporations and lead to greater opportunities (telemedicine, cloud-based workstations, e-commerce options)? These are questions we will not have clarity on for some time.
- In order to be reactive, we rebalance and/or add to equities if you’re able to do so, as the market retests the oversold low. Our process here at Second Level Capital is a systematic one, exactly for times like these. There will be a time and place to reassess everyone’s emotional capacity, but now is not the time to panic or change your strategy. If you started the year at a 70/30 (stock to bond) allocation, you’re account is down somewhere between 10%-15%. But most importantly, your percentage of stocks is now more like 55% and your bond allocation is now around 45%. When we go to rebalance your account in the coming days/weeks, the process dictates selling bonds, and buying more equities to get your portfolio back in balance. Having a system in place that takes the emotion out of this decision is the only way anyone would ever do it. If I took a poll of clients right now who are chomping at the bit to put more money in stocks, I don’t think I’d get too many takers, although it has proven over time to be the prudent action.
Something we alluded to as well in our previous post of March 9th was the idea of coordinated monetary and fiscal policy. We’ve seen a major step in that direction with the NY Federal Reserve offering $500 billion in repurchase bank lending to make sure the liquidity in the system remains high. I’m still waiting on the US Treasury and federal government empty the proverbial tank as well. A virus will not be the end of America as we know it. Now is the time for bipartisan government action to backstop small businesses, get money into the hands of those who need it most (service workers mostly), and look the nation in the eye while using the full faith and credit of the US government to fight this crisis of confidence.
The pain over the past three weeks has been unprecedented by many different metrics. But I’ll leave you with a quote attributed to Morgan Housel (one of the greatest financial writers of our time), who said,
“There are only 3 edges in the market:
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- You can be smarter than everyone else
- You can be luckier than everyone else
- You can be more patient than everyone else
What’s your edge right here, right now?”
We’re here to chat with anyone who needs a confident voice because we’ve been here before, and came out stronger on the other end. I believe we will again.
– Adam