Portfolio Management Strategy Amid Market Chaos

During periods like this, it is important for all of us to step back, take a breath, and attempt to gain some amount of perspective on what is happening. Just over one month ago, domestic markets were celebrating all-time highs and the economy was cruising. Today, the market is in “panic mode” and approaching an attitude of despondency, a key point we will touch on below.  

When markets are optimistic, forward-looking, and volatility is low (a month ago), they tend to be looking at traditional valuation metrics, utilizing FACTUAL data and long-term projections to ascertain the values of the business underlying each stock name. Fundamental investors, like us, look to purchase investments based on how they can appreciate based on the LONG-TERM underlying fundamentals of the business, sector, and region of the world they represent. Today, with volatility oscillating around all-time highs, markets are not thinking this way, and fundamental long-term valuation tools do not apply. What we are facing is an unprecedented health crisis that is quickly evolving into a financial crisis, the length of which is impossible to predict. With the size of the economic trench and the timeline associated to recovery (Yes, we will recover) not known, markets are reacting by the SECOND to each bit of news. All companies are working on ways to stop the bleeding in the face of this unprecedented period. This is not a cresting of the business cycle; this is an economic stoppage and the stock market will assume the worst when it faces something so unfamiliar.  Many experts in the medical field have advocated for a swift and complete shutdown to minimize the impact of the virus.  We would agree, and in our opinion, the current slow and elongated wave of closures and quarantines is not helping the issue quickly enough, in a twofold manner: one, it likely delays the inevitable containment and hopeful solution to this virus and two, it builds on the uncertainty of the economic impact.

 The economic impact may be severe in the short run, with potentially increasing unemployment and business closures. This can happen in normal business cycles but, in this period, the impact is likely to be far swifter and more dramatic. In response, we expect the government to step in and provide the proposed bailout being discussed in Washington (roughly $1.3 Trillion!) and likely many other waves of bailouts or programs to follow. Even while using the largest tools at its disposal, the government is not going to be able to prevent all damage. So, why does this matter and why are we still optimistic?

If we base our forward-looking opinion on facts and real data, there is light at the end of the tunnel. First, we have high conviction that this issue will not have the lasting impact of the Financial Crisis. During 2008 and 2009, the fear was a complete breakdown of the financial system.  In the peak and backside of that period, banks stopped lending and the housing market was crushed. This period was a structural breakdown caused by over-leveraged households and institutions; the healing process took years. That period not only impacted business activity during that treacherous period, we would make the argument that it impacts lending activity today. With this crisis, we are facing an ACUTE issue.  It is a severe demand shock while people are isolated, company revenues and personal paychecks will drop. However, there will be a day where economic activity starts again.    

Second, there is data to tell us that this virus can be contained. China and, more so, South Korea have shown the world that the issue can be dealt with in a relatively short period of time. You can see in the chart below that the problem was dealt with expediently in roughly one month. In what should be a glowing example for the United States and other countries left with crucial time to react, quarantines and social separation do work.   The primary difference today in the US is the slower proliferation of testing availability versus South Korea’s impressively quick response.   In the US, test distribution is accelerating every day and we are confident that increased availability will help identify, isolate, and hinder infected individuals from spreading the virus to others.

Third, markets present wonderful opportunities when fear is at its peak. We pulled out the now-famous op-ed piece published by Warren Buffett in the New York Times on October 16, 2008 titled: “Buy American, I Am.” When this commentary was published, the Dow Jones and S&P 500 were off roughly 40% from their respective peaks. He stated “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.” Does this sound familiar to today’s market environment?

He continues to say “Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497. You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.” This last point is an important one and the easiest to trust in good times and the hardest to trust in times like today. The market will reward you today with low values in exchange for your piece of mind. We believe it is our job to prevent ourselves and our clients from letting these very natural emotions dictate investment decisions.

So how do we develop fundamental investment decisions amid a market behaving on emotion and not fundamentals? Answer: we don’t change our way; we use it to our and our clients’ advantages. Over the last two weeks, we have made numerous portfolio changes in areas where many people may not be focusing their attention. As the market was falling and fundamentals ignored, US Treasuries were spiking in value as the 10-year treasury hit 0.38% and the 30-year hit 0.69%. We looked at this brief window to trim, in appropriate households, positions positively impacted by this development. In doing so, we accomplished liquidity for clients needing income and to provide capital that we believe will be effectively used when portfolios are rebalanced. We were not selling stock. Our goal, in all of our households, is to avoid having to sell risk assets (stocks) in the face of a temporary pullback in the equity market. We are also extremely confident that our knowledge of our clients’ cashflow, balance sheets, and timeline puts us in a unique position to apply such decisions on a household-by-household basis. 

 Our financial planning process sits at the core of our strategy in taking care of our clients. For our clients needing income and liquidity, we are confident this recent market correction does not immediately impact current income distribution strategies. We look at a time like this similarly to how we look at a year like 2019; while we never look to increase client income planning based on one substantially positive market year, we do not look to reduce income based on a poor year, let alone a poor quarter or two.  This idea cannot be overstated, and overreacting to emotional market machinations (in both directions) typically leads to a breakdown of a financial plan. We refuse to let that happen. 

For clients who are in their accumulation years, we continue to seek opportunities to buy low; after all, that is one of the goals of investing. This period offers the opportunity to purchase condensed value in stocks that are priced at values we have not seen in years. Whether it is accelerating annual contributions, converting funds to Roth, or making Roth contributions, one would be hard-pressed to argue that this is a bad long-term buying opportunity.

For our small business owners, employees, or anyone else who is immediately impacted by these difficulties or soon will be, we are here for you. We are here to help find creative solutions and to work with you closely to navigate through this, one step at a time. From the beginning we have been your partner and your advocate, now more than ever, please lean on us.

Our approach has not fundamentally changed. We will continue to apply consistent and unemotional decision-making processes to our investment process. We have been continually impressed with our clients’ stature during this uncertain time and we hope our approach and ongoing communication will give you additional confidence that this period too will pass. We will leave you with a chart we have used countless times and most often when markets are treacherous. It is simple but has held true through market history. It doesn’t take an Economic PhD to locate where we likely sit today.

https://moderntimesinvestors.com/investing/investor-emotion-cycle/

Please know we are always available to talk you through this market but more specifically how this window of market history has impacted your plan. As unnatural as this period feels, it is a healthy development from a market perspective. Equity markets must remind us from time to time that existential risks exist, and those risks present themselves at unpredictable times and from unforeseen sources. We are using this time to look for opportunity amid chaos and we appreciate your faith in us to proceed in that decision-making with your best interests in mind. We have faith in the global community to get through this period.