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Endurance: An Investor's Greatest Virtue Thumbnail

Endurance: An Investor's Greatest Virtue

One of my favorite investment stories comes from a conversation I had a few years ago. We were meeting with a new client and going over their accounts, beginning the process of preparing a retirement plan for them. Part of our discovery process requires us to take an inventory of assets and accounts, and as we went through their investments, we came upon a 401k statement from an old employer. 

This client told us that she hadn’t worked at that employer in over 20 years, and she had “forgotten about the account.” It had remained in the initial growth allocation she chose when enrolling in the plan.

Let’s take at some of what happened during those forgotten years:

At the time of this draft, global markets have experienced a significant downturn, and it is possible that we haven’t seen the end of this extreme volatility. I’ll admit that times like these can give you heartburn, especially if you stay glued to the television and your investment portals. However, I cannot stress enough that what we are experiencing at the moment is a normal part of investing. Sometimes, the best thing we can do is turn the tv off and simply breathe.

Before I share some thoughts, I’d like to be plain for a moment in defining 3 terms that you’ll hear repeatedly in the weeks ahead.

1) Bear Market – Bear Markets are defined as losses of 20% or more from a previous market close. We have had 15 bear markets (as defined) since 1926, with one occurring approximately every 6 years. (see footnote 1)

2) Recession – the economic definition of recession is 2 consecutive quarters of decline in GDP. 

3) The Market – Pundits and professional commentators often use the terms “the market” when they are really referring to the S&P 500 or DOW Jones. These are 2 US equity indexes that are fair representations of US publicly traded companies, but they do not define the total market which includes bonds, real estate, commodities, and other asset classes. 

A Word About Bear Markets—They Are Normal 

  • Bear markets are part of the investing cycle and an essential part of price discovery in the market. We can’t expect to have continuous years of growth without some large declines. 
  • The one-year return following a bear market has been roughly 47% (Footnote 1). 
  • Most bear markets have unique or unprecedented events that trigger the decline. It is not “Different this time.” 
  • Equities provide extremely valuable benefits to well-diversified portfolios; making radical changes in the midst of normal market volatility can be extremely destructive to client portfolios. 

Event-Driven Bear Markets Often Rebound Quickly 

  • Every bear market will likely trigger our emotions and bring fear to the forefront, however bear markets are typically triggered by either structural factors OR event-driven factors (specific events that shock markets). 
  • Structural bear markets tend to have greater magnitude relative to event-driven bear markets: 
  • The average duration and recovery time of structural bear markets is approximately five times that of event-driven bear markets. 
  • The Financial Crisis of 2008 had significant structural problems associated with financial institutions. I want to stress that we are not seeing these types of issues in the current bear market. This bear market downturn was highly event-driven by the onset of the Coronavirus. Prior to this outbreak, the US economy was giving very strong signals.
  • It may take some time for our markets process the recent uncertainty and let the emotions of investors play out. 

The aftermath of these latest events should leave us with a fundamentally strong environment for equities (stocks as an asset class). 

Our View: Equity Markets Are Quickly Becoming Attractive

  • COVID-19 triggered Maximum Pessimism. Markets are typically a leading indicator and have been quickly pricing in maximum pessimism caused by the virus. The virus is unquestionably a serious issue; however, our view is that the media has acted as a catalyst for fear instead of a source for high quality information. Fear of the unknown is often the greatest fear. As uncertainty weighs on various situations and potential impacts of this virus, it will be priced into stocks. The market is racing to estimate the economic impact of this event, and we feel that this is already reflected in market prices to a significant degree. 
  • The real economic impact of COVID-19 is small relative to the equity market decline. Reaction to this virus has caused tangible declines in growth output which will understandably has an impact on stock prices. Yet the global equity markets have declined to the tune of trillions of dollars, which is extreme relative to the actual economic disruption caused by the virus. Further, the economic disruption is temporary as uncertainty surrounding the virus dissipates. 
  • Interest rates have been decreased to the lowest level in years. This creates two themes that are beneficial for equities. First, cost of borrowing for consumers and business has been reduced. Lower cost of borrowing reduces expenses and encourages spending. Second, bonds have low rates creating very little competition for stocks. Stocks have increasingly attractive characteristics relative to many bonds, such as higher dividend yields compared to treasury bond yields. 
  • Oil prices have been volatile but are at the lowest level in years. The recent oil price shock created additional fear and uncertainty in the markets. This had an immediate negative impact on stock prices. Although this is still a challenge for energy-related companies, low oil prices are beneficial for many other types of business as well as consumers. 
  • Fiscal policy is a tool that remains in the toolkit. Monetary policy is an important tool used by central banks to spur economic growth (reflected in the current near-zero interest rates). Although monetary policy tools may be exhausted, fiscal policy is another important tool. Global governments will likely be aggressive in using government spending to initiate economic growth. Because the stock markets forecast economic growth, any news of fiscal policy initiatives will be positive news for equities. 

The Power of Planning

In our planning meetings, we continuously say that planning is a “process.” The good news for our clients is that we have created plans that prepared for this scenario. We can never predict the timing of events like this one, which is why we prepare in advance. Here are some of the areas of opportunity we are looking at currently:

  • Tax Loss Harvesting can be used for tax sensitive clients to harvest losses that can be offset against future gains. We like to consider these at all times throughout the year. At the moment, we are monitoring accounts for opportunities that make sense. *Note Tax Loss Harvesting is not synonymous with selling out of the market
  •  Now is the time to consider Roth Conversions; convert while asset values are depressed to save on taxes. This is a POWER move for IRA account owners. 
  • Some clients may want to strategically increase their portfolio risk to take advantage of the current equity market environment; this may be beneficial as long as the result is still within the client’s overall risk parameters.

Planning is a process, and we feel that there can be great opportunities that present themselves in the coming weeks and months. Our goal is to continue to work as diligently as possible to identify these opportunities and communicate them openly.

Footnote 1: https://www.fidelity.com/viewpoints/market-and-economic-insights/bear-markets-the-business-cycle-explained
Footnote 2: https://www.marketwatch.com/story/goldman-sachs-analyzed-bear-markets-back-to-1835-and-heres-the-bad-news-and-the-good-about-the-current-slump-2020-03-11?mod=taxes