The financial markets are taking a big dip this week over fears about the spreading coronavirus, erasing gains from earlier this year. You may understandably be nervous about your money and your family’s health.
Below are a few key items on what a prudent investor’s response may be as well as portfolio considerations in light of new information in certain markets.
At times like these, it’s important to put current conditions into perspective. Markets have generally been quite calm and upward trending over the last several years. Yet, calm isn’t the norm.
Declines of 10% or more happen about once a year on average. Stomaching volatility like this is a reason we can expect to earn higher returns over less volatile investments. There is no free lunch.
It is far too early to assess the ultimate impact of the coronavirus on economic activity and corporate earnings. Markets dislike uncertainty. It’s uncertainty, which leads to fear, that is driving stock prices down this week.
On a positive note, at this point, it seems unlikely that the coronavirus will cause the next U.S. recession. For that to happen, we would have to believe that the economic impact will last several quarters leading to a significant loss of US jobs and a drop in demand.
Initial jobless claims are not showing any weakness. In the graph below, you can see the trend has continued downward, indicating a healthy US economy.
It is important, however, to remember that economic activity and stock prices are two different things. While the economy has been strong, earnings growth – the primary driver of stock returns over time – was about flat in 2019. Despite this, stock prices returned more than 30% in the U.S. last year. Why? Investors enthusiastically and emotionally bid up stock prices.
Think of it this way. You buy a house in early 2019. It’s a nice home that is located in a nice neighborhood. Later in 2019, someone decides to buy your neighbor’s nearly identical home at a price 30% higher than what you paid.
The buyer gets a nice new home, but they overpay for the house. This is akin to what has happened in certain segments of U.S. stock prices, particularly in 2019. Good companies were bought but the prices paid were quite high.
While the coronavirus may not cause a recession, it certainly may cause high prices paid for certain U.S. stocks to reset to what is considered to be more normally valued.
Just as it was impossible to predict the exuberant jump in prices in 2019, it is impossible to predict what is to come in 2020. So what should you do?
Market timing sounds great. Who wouldn’t want to only be in the market when it goes up? Yet, the strategy has overwhelmingly been demonstrated not to be a reliable way to earn returns greater than simply staying invested through the ups and downs. Rather, it’s commonly a mechanism for investors to mistake activity for control. While it may feel better in the short term to go to cash, doing so generally destroys wealth in the long run. That’s a steep price to pay for short-term soothing.
So, if market timing doesn’t work, what, if any, portfolio adjustments should you consider?
You should continue to maintain a balanced approach to asset allocation, given the uncertain nature of the outbreak. Your portfolio is made up of stocks, bonds, and other assets that are designed to work together to provide diversification and reduce volatility. As stocks have sold off, U.S. government bonds have gone to record-low yields, delivered outsized returns, and provided great diversification benefits.
While maintaining a diversified portfolio is always prudent, some fine tuning should be done.
Given the now record-low yields, we will be making adjustments to the True Wealth portfolios. We will rotate to certain segments of the bond market that now offer more favorable risk/return tradeoffs, reducing our exposure to the very assets that have recently done so well but offer lower expectations moving forward.
In addition, we will be adding an allocation to income-oriented, core real estate investments. Income from these long-term leases from high-quality tenants should be more immune to economic shocks caused by the virus. This addition has been planned prior to Coronavirus and now makes even more sense.
High-yield, fixed-income investments in emerging markets are also becoming more attractive. With Asian and other emerging market central banks having more room to cut interest rates compared to the U.S., these fixed-income investments may further benefit from the likely monetary response.
As for stocks, in August 2019, we reduced what was an overweight exposure for most portfolios. We are at our target allocation for each portfolio and currently intend to remain there.
Further, we will continue to maintain a globally diversified portfolio. Both developed and emerging foreign stocks have held up better than the U.S. this week, despite the higher concentration of cases abroad. This is likely because bad news had been already priced into these markets, and the high valuations that exist in the U.S. do not there.
For True Wealth clients, you should expect to see activity in your accounts over the next days.
The coronavirus is causing uncertainty and fear. Fear is driving market sentiment. The herding mentality can drive extreme volatility and irrational behavior. The mistake is to react and go along with the herd.
Market volatility – both up and down – may persist until the virus is contained. Yet, we truly believe that this will become a distant memory like SARS, MERS, and the Swine Flu. They are all serious diseases but just a blip in the grand scheme of things. None destroyed any client’s financial well being.
Most importantly, we encourage you to stay focused on your long-term goals. We have made plans and stress-tested for much worse than what has occurred. Your spending needs in the next few years are not reliant on stock market returns. You have time for stocks to rebound.
View your financial plan results in your client vault. They are updated daily. If you are in the green zone, you have little risk of the temporary market decline impacting your lifestyle and spending ability in the long term.
Keep in mind that we monitor your portfolios daily. We will realize any tax losses to save you money and utilize our rebalancing strategy for you as opportunities arise. This is our way of taking advantage of the price declines in the market.
You can be certain that we are monitoring events closely, and we’ll continue to provide updates as needed.
As always, please feel free to contact us if you have any questions.
Kevin Kroskey, CFP®, MBA | Chief Investment Officer