In a world where nothing is certain right now how do we know when it is time to buy?
This article was revised and updated on March 17th, 2020.
We are facing something we have never faced before in our lifetimes. That is a fact and, during a time when the news of the pandemic spreading and the recommendations on social distancing getting broader by the day, it can be hard to feel certain or safe about anything.
As troubling as it is to watch the unprecedented market decline and hard it is to tune out the fact that you know you are losing a lot on your investments, we need to maintain our health and the health and safety of our family, friends, and neighbors as the number one priority. Covid-19 which emerged late in 2019 in China has spread rapidly worldwide since then and is a global pandemic. The measures taken by leaders around the globe have been strong leaving most children without a classroom to go to, parents working from home or without a job altogether and investors panicking about what is to come.
This disruption to daily life and to our psyches is substantial and it’s terrible. The coming weeks will not be easy, but these measures are practical and prudent.
Although this pullback is dramatic, and understandably causes alarm, it must be seen in the context of an extraordinary 44% rally in the S&P index from Christmas Eve 2018 to its peak on February 19th, 2020 (Morningstar). Despite unprecedented events, as of March 17th, 2020, economic fundamentals seem no different, except now, in addition, we are facing the disruptions of the coronavirus, and the yield curve has repeatedly turned negative, so it would not be inconceivable for the market to decline another 20%-40% from here. If only temporarily.
So why don’t we reduce risk more?
Because we already took the highly unusual step of significantly reducing risk a few months ago. Then, we waited as the S&P continued to climb even further having one of its best years ever. As the S&P hit new all-time highs despite the first signs of the coronavirus, we were further tempted to eliminate equities entirely. However, having been wrong for several months, and with fixed income offering pitiful returns, this could have just made us more wrong.
And if we were wrong, and markets had kept rising, when would we buy back in? This same decision faces us today. Markets could turn on a dime, and clients will be stuck in extremely low yielding bonds and cash yielding less than inflation.
But this begs the question, why had we pulled back risk initially? Our concerns were that the market just seemed to keep taking off, ignoring any underlying economic fragility such as the negative yield curve, the budget deficit, and the Fed, which seemed too concerned about goosing asset prices, being out of ammunition for when a “black swan” event hit. Did we know this black swan was coming? No. But we were aware that epidemiologists and financial experts have longed warned that this kind of pandemic, most likely coming out of Asia, was almost inevitable. We didn’t know when it would hit, but we were surprised that financial markets were so euphoric that they initially ignored it. But most of all, we felt the market was priced beyond perfection in a very imperfect world.
If the coronavirus blows away with the summer and a vaccine is developed all could quickly return to normal. Alternatively, cracks in the economy could be exposed by the significant disruption and as the tide washes out it could expose all those businesses “with their pants down”, as Warren Buffet has famously put it.
However, at root, we feel much more confident at these more realistic equity values. And although there has been a lot of froth and likely some wasteful investments in the technology and private equity sectors due to all the “free money” sloshing around, we think in terms of the economy, even if it resets, we remain in a golden age of invention that will eventually continue to power us forward.
We understand that clients and investors are extremely concerned about their accounts right now, and indeed there will be areas of pain. The good news is that all portfolios contain enough stable investments to sustain clients for years to come. Meanwhile, we have plenty of dry powder to invest at much better prices when the dust settles. It is never simple. And either we will miss the upside and be too conservative, or we will need to start putting money painfully back to work, as markets continue to decline. Either way, clients should start to look at this as a healthy opportunity, to get equity exposure at more realistic values. Such opportunities will provide investors with the best chance of keeping ahead of inflation in the decades ahead. Stay safe and wishing you the best of health.