By SJS Senior Client Portfolio Manager Tom Kelly, CFA
Every day, events happen that are outside our control.
While we may not be able to control what happens around us, what we can do is identify the risks we know of, craft a plan to act appropriately given those risks, act according to the plan, update the plan upon receiving new information, and repeat this process. This tends to be true in health-related matters as well as with investing.
SJS previously wrote about the coronavirus, and our general message stays the same. Since that post, there has been more significant stock market volatility, a new oil price war between Saudi Arabia and Russia, as well as continued societal consequences worldwide due to the spread of the coronavirus.[1]
Here are a few key insights regarding our thought processes and systems in light of the recent stock market volatility and associated news events.
Educate yourself with reliable sources intended to help the general public.
Generally, and particularly in uncertain times, it is critical to receive information and lessons from the most reliable sources who intend to help the general public. Over the past few weeks, many news sources have published a lot of sensationalized stories with little-to-no new and useful information for helping people handle the consequences of the coronavirus. At SJS, we focus on high-quality information from sources including the Center for Disease Control (CDC) and World Health Organization (WHO).[2],[3]
Focus on important short-term and long-term economic indicators.
Long-term investors focus on fundamental economic conditions that drive returns, as well as market valuations relative to those fundamentals. For well-diversified global portfolios, general economic growth (as measured by indicators including gross domestic product (GDP)) drives much of the stock market returns that clients will realize over the long-term. Most economic firms believe that although GDP growth will slow down in the short-run, the coronavirus and oil effects should not significantly alter long-run economic growth expectations, which is what long-term investors should focus on.[4]
Design portfolios that can grow from risk and uncertainties.
Many studies have shown that asset allocation (deciding how much of your portfolio to allocate to stocks and bonds, respectively) drives over 90% of variability of returns, meaning that individual security selection and market timing have little positive impact on expected returns for most investors.[5] In light of this, SJS works closely with each client to develop a well-diversified global portfolio using institutional quality mutual fund that is true to the client’s goals and risk tolerances. (Diversification neither assures a profit nor guarantees against a loss in a declining market.)
For stocks, SJS invests globally in 10,000+ securities through institutional quality mutual funds, understanding these funds will move similarly with general stock markets. For bonds, SJS invests primarily (90%+) in thousands of high-quality investment grade securities, also using institutional quality mutual funds, which tend to perform relatively stable or even positively during times when stock markets are volatile.[5] For example, over the past few days, non-investment grade credit bonds (especially in the energy sector) have decreased significantly in price (likely in part due to the new oil price war), while most high-quality bonds have increased in value.[1] A portfolio consisting of a well-diversified mix of stocks and high-quality bonds is not expected to experience the same volatility or losses as what general stock markets will experience.[6]
Rebalance to influence risk, improve returns, and tax loss harvest.
During volatile stock market periods, rebalancing according to a robust systematic process can both move the portfolio back to targeted expected risk characteristics, with the goal of improving long-term portfolio performance due to selling more highly valued bonds and buying lower valued stocks.[7] Additionally, volatile stock periods tend to provide more tax-loss harvesting opportunities, which may increase long-term after-tax expected return. SJS has robust systems and processes in place to facilitate such rebalancing and has been working with clients to perform any relevant trades over the past several weeks.
History does not repeat itself, but it does rhyme.
Over the past 50 years, the world has experienced many significant stress events, due to health concerns, economic issues, wars, and so on. Below is a chart of the MSCI World Index since 1970 detailing performance and associated stress events.[8]
Additionally, over the past 100+ years, the world has experienced major pandemics like the Spanish Flu (1918-1920), which impacted roughly 27% of the world’s population.[9] Below is a graph of the S&P 500 and associated performance during and after these pandemics.[10]
Throughout these events, people reacted with resilience, and markets continued to function.
Sudden and complex events will happen. We do not know what these events will be, nor exactly when these events will happen – but we know that they will happen. We believe in the resilience of human beings, and accordingly we believe in the long-term growth prospects of global economies and investment markets. Because of this uncertainty and risk, we at SJS help clients focus on what they can control and allow markets to do the rest. We continue to recommend that our clients rely on MarketPlus Investing to stay invested in well-diversified global portfolios true to each of their goals and risk tolerances.
If you have specific questions or concerns, please call us. We’re always here to explain and assist.
Sources:
[1] “High-Yield Bonds Are Sinking as Bankruptcy Fears Hit the Oil Patch.” Alexandra Scaggs, barrons.com.
[2] “Coronavirus Disease 2019 (COVID-19).” Center for Disease Control and Prevention, cdc.gov.
[3] “Coronavirus disease (COVID-19) outbreak.” World Health Organization, who.int.
[4] “S&P: Coronavirus to trim 2020 global GDP growth by 0.3 percentage point.” S&P Global, spglobal.com.
[5] Unconventional Success. David Swensen, 2005.
[6] “3 Reasons Why You Should Invest in Bonds.” Nick Maggiulli, ofdollarsanddata.com.
[7] “Opportunistic Rebalancing: A New Paradigm for Wealth Managers.” Gobind Daryanani, fpanet.org.
[8] In US dollars. Source: Avantis Investors. MSCI data © MSCI 2019, all rights reserved. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.
[9] “1918 Pandemic (H1N1 virus).” Center for Disease Control and Prevention, cdc.gov.
[10] In US Dollars. Sources: Avantis Investors, using data from Robert Shiller Data Collection at Yale University and Centers for Disease Control and Prevention. S&P 500® Composite Index does not include reinvested dividends.
Important Disclosure Information
Indices are not available for direct investment. Their performance does not reflect the expenses associated with management of an actual portfolio. Mutual fund investment values will fluctuate, and shares, when redeemed, may be worth more or less than original cost. Diversification neither assures a profit nor guarantees against a loss in a declining market. There is no guarantee investment strategies will be successful. Past performance is no guarantee of future results.