Tumultuous Quarter
Anxiety is high. Most of us are nervous – not just about the financial markets and the economy. We worry about our health and the health of our family and friends. The current situation is stressful, forcing us to take it one day at a time. As we all get through the next days, weeks, and months, we must remember that we will come out on the other side of this unprecedented time.
There is no sugarcoating it; 2020 started out rough for investors. Global stocks are down 21.4% this year, marking the worst quarter for stocks since 2008. The losses were sudden. From their peak in mid-February, two years of gains were wiped out in just 35 days.
High-quality bonds successfully buffered stock market losses for balanced portfolios. A traditional balanced portfolio holding 60% in global stocks and 40% in U.S. intermediate-term bonds showed losses of 12% YTD, versus 21% for an all stock portfolio, while a “50/50” portfolio was down 10%.[1]
THE CHALLENGE AHEAD
This is not like any other economic contraction. Typical contractions often result from a build-up of excesses like mortgage debt in 2007-2008 or excessive enthusiasm for dot-com stocks in 2000-2001. This time many businesses that were viable and healthy in January suddenly were not in February.
For the week ending March 28th, 6.6 million people filed for unemployment benefits, marking the single largest jump in jobless claims on record. Some economists believe US GDP contracted by as much as 34% (annualized) in the first quarter of 2020, potentially the largest quarterly decline on record.
Governments and central banks are doing what they can to soften the short-term blow to the economy. Congress passed several stimulus bills to aid businesses and their employees. The Federal Reserve has taken drastic measures to provide monetary accommodation by committing to keeping rates low and opening several emergency lending facilities. All of this gives us the best chance to get through the health crisis and towards an eventual economic recovery.
While the current contraction is severe, its duration will be key. If the spread of the virus slows, the impact of the economic shutdown could be relatively short-lived – more like a catastrophic nation-wide storm than a multi-year hit to the economy.
Still, we face a health and economic battle ahead. Stock prices have dropped considerably. They could fall further if the markets start to anticipate a much longer impact on the economy. It’s also important to remember that the financial markets will recover before the fundamentals do. The markets will begin to anticipate improvements in the economy, and, most importantly, a slowing of the infection rate before they happen. Waiting for more clarity or signs of recovery to “get back in” can be costly.
Take the recovery from the 2008 financial crisis as an example. From the low on March 9th, 2009 until the peak 11 years later, the S&P 500 returned over 528%. For investors missing the first three months, or just 2% of the total recovery time, returns dropped to 348%. That’s the difference between $100,000 turning into nearly $629,000 compared to $448,600, or 44% less money. The ups and downs can be especially hard to take when the world feels this uncertain, but the strongest returns occur when the situation seems most dire.
WHAT WE ARE DOING
The temptation is to sell stocks when they are down. But attempting to time the market is challenging and generally counterproductive, especially when markets are moving at hyper-speed. The value in certain assets, such as stocks, is their long-term growth potential. The trick is to withstand the short-term swings to capture the long-term value – a focus we continue to recommend.
However, that doesn’t mean we aren’t doing anything. In the past weeks, we have taken extra measures to ensure our bond portfolios and cash positions continue to buffer the decline in stocks. That means emphasizing high-quality bonds and short-term investments. Ensuring the stability in these parts of the portfolio will hopefully allow clients to maintain a long horizon when it comes to the stock allocation.
Within stocks, our focus is on broad diversification across high-quality companies. While we effectively reduced our exposure to large European companies, we are maintaining exposure across countries outside the US. The extent and timing of the infection is affecting international economies differently. This helps the portfolio withstand shocks in any one country.
Our review of stock positions is ongoing. We want to make sure portfolios are well-positioned to get through this turmoil. We have reduced exposure to some industries we feel are particularly vulnerable or the outlook is especially cloudy. Our focus is on companies with strong financial positions and healthy balance sheets.
We also continue to harvest losses in stocks, immediately putting the proceeds into similar, but not identical, investments. For example, we sold one foreign stock fund and replaced it with a fund based on a slightly different index of companies. That way, we can keep investment plans intact but capture the resulting losses, which can be used to offset capital gains now or into the indefinite future, or to deduct up to $3,000 annually against other income.
WHAT IT ALL MEANS
A new “normal” often results from a major crisis. It’s hard to imagine when we will be shaking hands again. Some of us will sharpen our at-home culinary skills or realize we don’t need as much clutter in our homes.
Our ability to look one or even two years ahead rests on the confidence that we have a solid plan in place. These are the times when planning and patience are most rewarded.
Investing is a life-long, step-by-step process designed to reach financial goals – to educate children, enjoy a comfortable retirement, and ensure funds are there for unexpected needs. Markets fluctuate and returns go up and down. The only metric that matters is progress towards your goals – goals that don’t change with the markets.
A good plan is one that aligns with your situation. It incorporates your needs for short-term cash and longer-term liquidity. A good plan is one that gives you comfort in knowing you can get through the short-term challenges. It also means having a well-diversified portfolio that, while not immune to the swings in the market, is constructed to withstand turmoil and get through to the other side.
Clients will receive our Q1 investment reports in the next few days. We are available to discuss any questions or concerns about your individual situation. In the meantime, please stay safe.
[1] Returns are calculated using the MSCI All World Stock index and the Barclays Intermediate US Bond index. Indexes are not investable; returns are illustrative only and do not reflect the impact of fees and other expenses.
Contact us at 865-584-1850 or info@proffittgoodson.com
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