At the beginning of each year, we typically present an investment outlook and ideas for a prudent portfolio. Before the coronavirus was a big story, we were contemplating another piece on bonds. We expected pushback, as in today’s low interest rate environment bonds produce paltry returns, versus the equity markets hitting new highs on an apparent upward trajectory. What a difference a couple of weeks can make.
The extreme volatility and almost weekly sell-off we are seeing in equities now is a sober reminder that markets do not go up forever. And the situation drives home the tenet that markets are driven by fear and greed. Greed was in full force when the Dow Jones Industrial Average (DJIA) hit a new high on February 12 of 29,551. And fear was the culprit causing it to plummet to 23,851 at the close on March 9—a total decline of 19% from the high. That is near bear-market territory. The S&P 500 and NASDAQ indices suffered a similar bloodbath.
We have seen extreme volatility before. Some of us remember October 19, 1987, when the DJIA fell 508 points (a 22.6% drop). After the terrorist attacks on September 11, 2001, the stock market fell from 9,605 to 8,921 when it reopened on September 17, a decline of 7%. At the height of the 2008-2009 Financial Crisis, the S&P 500 Index crashed nearly 60%, and it took until 2013 to fully recover.
No one can predict where this current market sell-off will end, or when, because it is next to impossible to measure the depths of investor panic. But one thing we do know: Selling into a panic means locking in losses. Peter Lynch, who once managed the Fidelity Magellan fund, generally cautioned investors to wait 30 days before taking action. Yes, the market could drop further, but it just as easily could turn around. A 30-day window may provide added perspective.
It also is a good idea to review fundamentals. We have solid employment, the most important economic statistic. Also, the most recent reading for retail sales ticked up by .3%, suggesting the consumer (accounting for 67% of our gross domestic product) is still spending. And the latest reading for consumer confidence is 130, its highest level in six months. In response to the coronavirus crisis, The Federal Reserve slashed interest rates last week to give businesses some relief, and the New York Federal Reserve Bank added $50 billion in liquidity to overnight lending, according to an article in the March 9, 2020 edition of The Wall Street Journal. And the Fed is expected to further encourage cooperation between banks and their customers, as it has done with other natural disasters, should it be necessary. But, with the world’s energy markets under pressure and the disruption in global supply chains, we can expect to see some erosion in employment. Most economists see a low likelihood of recession, but do not dismiss a period of choppiness.
Finally, this extreme volatility is a wakeup call for investors to examine their asset allocation, the bedrock of sound portfolio management, and review its rudiments.
- First, financial planners suggest that every investor have six months’ of living expenses socked away, just in case.
- Second, when markets are soaring, it is tempting to be fully invested in equities. But equity markets will always have volatility, because equities trade on expectations of the value of future corporate earnings. Whenever those earnings are in doubt (as they are now), investors sell. Some of them sell a lot.
- Third, maintaining a cash reserve in a portfolio (separate from living expenses) provides the wherewithal to buy good companies at bargain prices.
- Finally, having a position in bonds stabilizes the portfolio, even when interest rates are low, providing security to investors when equities are in freefall. Purchasing bonds (once interest rates move back up) may sound like locking the barn door after the proverbial horse was stolen, but it is sound advice and will protect portfolios when the next bout of volatility hits. Bonds do not lose their value—in fact, when interest rates decline, the value of the bonds rises. When looking at a portfolio awash in red (indicating declines in equities), it can be comforting to see the bond portion of the portfolio in solid black.
In summary, the coronavirus, like any sickness, must run its course. Just as those who become sick suffer some uncomfortable symptoms, investors will be uncomfortable until the markets stabilize. It is not a time to panic. Those with cash on the sidelines can research opportunities to buy. And everyone should review their portfolio and make plans to reposition it, if need be, when the panic is over, to prepare for next time. Because one thing we know: there will be one.
This article is not meant to be financial or investment advice. Please be sure to consult with your accountant or financial advisor for all investment advice.
