Reflecting During a Tough Market

April 28, 2020
Share |

The global upheaval has truly been unprecedented. In a short amount of time the world has experienced one of the worst pandemics since the Spanish Flu (102 years ago), the largest economic contraction since the Great Depression, the greatest oil-price decline in the OPEC era (or possibly ever), and the most extreme central bank/government intervention of all time. Being the first “self-induced” economic and market recession in history, the market responded accordingly.

Howard Marks of Oaktree Capital put it bluntly in his last memo writing, “The future for all of these events is clearly unknowable. We have no reason to think we know how they’ll operate in the period ahead, how they’ll interact with each other, and what the consequences will be for everything else.”

Extrapolating from the past is often one of the only ways to deal with the future, but blind faith in the relevance of past patterns makes no more sense than completely ignoring them. If we were to look at the past “virus scares” and their global impact compared to the current virus, the impact now is certainly hard to compare. However, despite past viruses or economic crises, the market has found a way to look towards positive future developments. Our broader point, simply, is that investing is a long-term endeavor, and the “journey” can sometimes be quite volatile.

If we accept that, as bad as current events may seem, they will eventually improve, then what should we do going forward? Below is a short list of things to consider.

  • Diversification continues to play an important role in investment portfolios.

With the S&P 500 outpacing the majority of asset classes over the last 11 years, it seemed as if diversification was a thing of the past. As Ben Carlson of Ritholtz Wealth Management put it, “Diversification can make you feel like you’re running uphill with a weighted vest on during a bull market.” It is only during uncertain times when you realize the importance of diversifying between uncorrelated assets.

When the major indexes that most investors watch are going up year after year with very little disruption it is easy to convince yourself you are willing to take on more risk to be on par with the returns you are seeing in headlines or hearing about from friends.  When invested in a well-diversified portfolio it may feel like you are losing out on the action.  However, what is true with most things in life is true with investing; there are trade-offs between the choices we make, and you can’t have everything.  Higher returns when the market is doing well will undoubtedly bring lower lows when the market experiences a downturn.  It is important to be honest with yourself before the market experiences a downturn about what kind of volatility you can handle, both financially and emotionally.  Investors should decide on a risk profile that suits their goals, time horizon, and that they can live with in good times as well as bad.

To highlight some of the benefits of diversification, we constructed a combination of various stock/bond portfolios and presented their year-to-date performance below. For example, a 40/60 portfolio consisting of the world stock market (MSCI ACWI) and the Barclays Aggregate Bond Index is down only 3.4% this year compared to a 11.7% decline in the U.S. stock market.

Source: Data and Graphs: Bloomberg and Nova R Wealth; S&P 500 = S&P 500 TR, Aggressive Growth = 100% MSCI ACWI NR, Moderate Growth = 80% MSCI ACWI NR/20% Bbgbarc US Aggregate Bond Index TR, Balanced = 60% MSCI ACWI NR/40% Bbgbarc US Aggregate Bond Index TR, Moderate Conservative = 40% MSCI ACWI NR/60% Bbgbarc US Aggregate Bond Index TR, Conservative = 20% MSCI ACWI NR/80% Bbgbarc US Aggregate Bond Index TR. Returns as of March 23, 2020. No fees, transaction fees, or taxes are considered. Investors cannot directly invest in an index.

 

  • Remember to stay disciplined in your long-term investment plan.

Trying to time the market is extremely difficult to do, and market lows often result in emotional decision making. Investors have historically proven to be poor market timers, which has cost them significant long term performance. Investing for the long term while managing volatility may result in a better outcome without the emotional headache.

If we were to look at the period from the beginning of 1999 to the end of 2018, six of the best 10 days occurred within two weeks of the 10 worst days. Even more recent, the worst days of 2020 so far have clustered within a span of two weeks, and the best days have followed shortly after not even a week or two later.  When the pressure is on it can seem like a logical move to cash out and wait for better days to get back in to the market.  However, as research shows this can be (and usually is) detrimental to your long term returns. 

Trying to sell out of everything and waiting till the dust settles often proves to be difficult for a number of reasons: (1) The “all clear” sign to get back into the market is found usually after the fact, and by then the market has already reached higher ground than when you sold. (2) Holding cash becomes a burden once the initial bounce occurs, and investors wait for another big “dip” to buy back in that may never present itself.

The chart below illustrates the performance lag experienced by investors over various time frames.  This performance lag shows us how much difference there was between market returns and average investor returns.

To summarize, even though we are in the midst of an economic and market storm, we still should keep our eyes on the longer-term horizon and plan accordingly.