Anyone that has read any of the posts that I’ve written over the last couple of years, and especially those written in the last six months, knows that I have believed that the highs achieved in the S&P 500 in January of 2018 represented the beginning of the end for this market cycle. In my opinion, much of what was achieved beyond that level was achieved through easy money policies enacted by central banks around the globe to stimulate their respective economies. So, no one should be terribly surprised that I’m not terribly surprised by the recent spike in stock market volatility and the accompanying decline in valuation. Like everyone else, I am, however, surprised by the catalyst. Who could have seen this coming?
“Who could have seen this coming,” they will say. Those that never bothered to assess valuations or consider what they were buying or selling to any extent beyond what had performed well lately will blame the surprising nature of the catalyst that forced people to finally pay attention to math for their being caught off guard. Well, historically, the catalyst is very frequently surprising – if it can be identified at all. What should not be surprising is that, from an investment standpoint, buying things when they are expensive relative to their ability to generate income on a historical basis frequently produces an underperforming allocation of capital for some subsequent period of time.
There is a running joke on Wall Street that is one simple statement: “It’s different this time.”
The joke is that this statement marks the famous last words of many investors that, for whatever reason, believe the economic realities that have operated in cycles since at least the beginning of recorded history have somehow been suspended in the present age. The fact that whatever specific catalyst that brings about the next stage in an economic cycle is surprising should in no way be an excuse for not utilizing prudent judgement, common sense, and a bit of math to try to determine how one should allocate their assets.
I mention all of this now because there is much information about current economic circumstances being spread about in investment circles and among the investing public. Some of it is polarizing and, I believe, potentially dangerous. Now, I understand that I have been a vocal sceptic of U.S. equity valuations for some time and, therefore, might be thrown into a camp for current valuation skeptics. This is true enough when it comes to my assessment of relative value, but I am no epidemiologist. What I’m specifically referring to here is information about how the effects and side effects of the COVID-19 virus will play out within the global economy, and the resulting impact on any given individual’s personal finances.
The present reality is that there is a virus that is spreading around the globe that, if nothing else, is disrupting human behavior. In some areas, to various extents, some people are altering their work, life, and social habits. When the behavior of enough people changes, it has the potential to alter the dynamics of economies. The greater the number of people that change their behavior, and the longer the period of time that their behavior is changed, the larger the potential effect on various aspects of various economies. This doesn’t necessarily mean that the impact of change is negative, just that the dynamics might change.
At this moment, it appears to me, based on information provided by sources such as WHO and our CDC, that there is no real way to assess what the impact or scope of the COVID-19 virus will be. However, some are speaking as if it will almost certainly end in global catastrophe and others are dismissing the potential societal and economic impact entirely. Both seem unreasonable at this particular juncture.
What does seem reasonable, as ever, is for each individual investor to consider their own specific investment objectives, investment horizons, and tolerances for risk. When someone understands what they are trying to achieve and how much portfolio variance (risk) they are willing to tolerate to achieve their goals, it is much easier to evaluate what needs to be done to accomplish these goals. Of course, for any of this to make sense, one must also understand the assets that they might utilize to achieve their objectives. This understanding must include how a particular asset might behave under various circumstances and in conjunction with other assets that might be utilized within the same or related portfolio. It also includes at least an attempt to understand whether or not a particular asset is expensive or inexpensive at the present, relative to both its past and potential future valuations.
In my personal experience as of late, investors are being encouraged to “stick it out, stay invested, or buy the dip!” or “sell everything and buy gold” (those are hypothetical and/or paraphrased quotes, by the way) without consideration of what the investor is actually trying to accomplish. I was forwarded one such note just today:
“We suggest looking through any earnings weakness as we expect it to be transitory.
One small nugget of good news is that many companies had already been shifting supply chains from China due to the Trump Tariffs. If they weren’t considering it before they will be now as they realize the importance of diversification.
Expect this trend to accelerate moving forward. The US consumer is on solid footing and will continue to be one of the key drivers to US economic growth in the year to come. We believe, just like all the other viruses we have seen over the past decades that have dissipated, the Coronavirus will be no different. Some have suggested that the 1918 Spanish Flu, which killed hundreds of thousands in the US could happen again. No one knows, but 2020, is not 1918. Technology and news move much faster and the US rebounded from the Spanish Flu when all was a said and done. We suspect that any drop in earnings or economic activity will be short lived, and more than made up for in the year to come. Don’t panic, stay invested.
This report was prepared by First Trust Advisors L.P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.”
The author of this report might end up being accurate – and I, for one, certainly hope they are – but there is simply no way that they could know what the outcome might be with such a high degree of certainty to provide the blanket advice “stay invested” without understanding the circumstances of each member of their audience. The potential result is an investor that could be taking more risk than is required to achieve their objectives, and possibly more risk than they ever intended to take in the first place.
There is no way that we can know now what the economic landscape will look like in one or two months or one or two years with this new variable being added into the equation. Behaving as if one does is pure speculation and potentially quite dangerous.
It is never a good time to panic, but it is always a good time to do the math. Investors should understand what they are trying to achieve, assess all possible outcomes, and invest as if there is no way they could possibly know how this new variable plays out, because, at this point, it doesn’t appear that anyone really has that information.