The bull run in American equity markets officially ended on Thursday, March 12th. At the end of that day, S&P 500 index stood at 2480, about 26 % below the peak S&P 500 closing of 3386, reached just 3 weeks prior on Feb 19th 2020. The markets rebounded about 9.29 % on Friday, March 13th, and at closing, S&P 500 index was just shy of the bear market definition of 20 % decline. With ^VIX, the market volatality index hovering near multi-year highs, it is natural to wonder, what to do?
Let me begin with the following quote from Warren Buffett, circa 2009
“There’s always a lot of things wrong with the world. Unfortunately, it’s the only world we’ve got. So we live with it, and we deal with it. But the beauty of it is that this system works well. I dont have the faintest idea what’s going to happend in the next year or two years. But the one thing I know is that, over time, people will live better and better in this country. We have a system that works. It unleashes human potential.”
Quintessential bullish Americana sentiment, one that I whole-heartedly agree with.
That said, I see three paths to action in these times of uncertainty.
- Get out, things are going to get a lot worse:
WHO declared Covid-19 a pandemic earlier in the week. Trump declared national emergency on Friday. The entire nation of Italy is under quarantine. Coronavirus is wreaking havoc on travel and tourism industry, shutting down public sporting events, closing down schools and testing the limits of healthcare capacity in all parts of the world. Clearly not good for global economy and the markets. By the way, how about we are just getting started! Except for China, which took the draconian measure of mass quasi-quarantine to suppress the spread of Covid-19, the rest of the world is nowhere close to peak!
I may be getting ahead of myself, but given the dire scenario, it may be prudent to get out sooner than later. The fundamental premise underlying this plan of action is the thought that we are no where close to bottom and it is possible, with a high degree of confidence, to predict market bottom and thus time the entry into market to one’s advantage. A prudent course of action for folks who adhere to this idea is indeed to go all-cash waiting for the most opportune moment to get back in!
NOTE: While I was penning this article, news broke that Fed has cut interest rates to zero and will buy atleast $700 B in government and mortgage-related bonds! Talking of ugly, it sure seems we are in for some ugly times!!
How ugly? history is our guide. Lets look at the top worst market drawdowns of last 100 years.
Recession is defined as period of two consecutive quarters of negative GDP growth. Not all bear markets lead to recession neither all recessions lead to bear markets. However, in the periods of biggest market drawdown, as shown in table above, bear markets are leading indicator for a pending recession.
The chart below shows that we have experienced the fastest decline to 20 % of all market drawdowns greatet than 20 %.
It may very well be the case that with no end to pandemic in sight, the market drawdown will continue into recession and we could be staring at a 50 % (or greater) drop in the markets. Getting out of markets at 19% drawdown then seems like a no-brainer!
- Do Nothing
When it comes to investing and being successful at that, one cannot ignore the laziness arbitrage. Going back to the table above, the two massive drawdown periods of the last twenty years, were each related to a single business sector, tech in 2001 and banking in 2008. Folks heavily invested in these sectors, assuming, their investments were in good businesses, such as MSFT and not eTtoys for tech and Wells Fargo and not Washington Mutual in finance, and those who were able to ignore the noise surrounding the panic driven sell off, are now sitting on massive returns.
For example, Microsoft (ticker: MSFT) reached a peak value of $58.38 during the dot-com bubble and as of this writing MSFT is trading at $158.83, thats a 3X gain just in stock price, not withstanding the reinvested dividends over the past 20 years.
The following chart from article by JP Morgan titled, The beauty of doing nothing, is spot on
The global financial crises is but a blip on the chart. Market cycles are inevitable, the reason for drawdowns may vary, this time around it is virus pandemic, the last time it was financial system collapse, however, it has generally been fruitful to pay respect to economic gravity and stick with markets over time.
The chart below (again from JP Morgan article) is yet another reminder of futility of market timing and the inherent risk of cashing it all out!
The penalty of missing the 10 best market days, and 6 of which occur within two weeks of 10 worst days is quite hefty. Just when the outflow is maximum we tend to see best return days. Just look at what happened on the last two trading days of the past week. On Thursday, Mar 12th, the markets dropped 9.99 % for the worst performance since black Monday of 1987, which was immediately followed by a market rise of 9.29 %. I am just not sure if any retail investor out there was able to sell on Wednesday evening just before the markets hit bottom on Thursday to then get back into the market on on Friday morning.
For folks such as myself, who know next to nothing when it comes to predicting how the events of future will play out, doing nothing does seem rather attractive!
- Double down, it was heck of a long wait!!
Folks who believe in buying businesses at reasonable price, sure feel now is the time. Quite a few good businesses that were selling for a premium just two weeks prior are now being offered up for sale, especially the ones most hit by the virus pandemic, i.e., oil, travel, tourism and banking sector.
Below is a snapshot of email communication between Whitney Tilson of Empire Financial Research and Enrique Abeyta, editor a Empire,
“Something just happened that’s extremely rare: the S&P 500 fell more than 5% in a two-day period.
I actually think that a super-high-velocity move like this is very bullish because it’s a sign of quickfire panic as opposed to an unwinding of liquidity.
Such a sharp drop has happened only 47 times in the last 20 years. During this period, there have been 5,484 trading days – so this happens only 0.86% of the time.”
The full communication thread is available here! The upshot, if history is any guide, now is the time to go bargain hunting!
Jason Zweig put it best in his most recent wall street article titled, Stocks are in Chaos. Control the One Thing You Can,
“Investing now more than ever, is about controlling the controllable. You cant control the markets. You cant control the coronavirus. You can control your own behavior..”
This quote reminds me of the essential lessons of stoicism…
“Stoicism teaches how to keep a calm and rational mind no matter what happens to you and it helps you understand and focus on what you can control and not worry about and accept what you can’t control.”
Stoicism is my guide to navigate these uncertain times. Of the three action paths, neither the all-out nor the all-in strategy suits my temperament. Given my style of investments, in times like these, neither is not doing anything a suitable strategy for me. So how am I navigating the waters.. here’s how
- Making sure I maintain 2 years worth of living expenses in liquid assets! This ensures I under no circumstance sell my equity assets at wrong time to simply fund AVI family life-style.
- Be accepting of sunk cost! My oil investments may very well go to zero! No point worrying about consequence of decision made without an ikling of foresight into the events that no-one could foresee coming.
- Gradually sell assets held in AVI-family active portfolio as a hedge against a sudden market collapse, i.e., gold and short-term bond assets, and deploy those funds to buy stocks of good businesses with strong balance sheet
- Make IRA contributions for years 2019 and 2020 now and deploy these funds to further boost equity holdings in good businesses
- Increase my 401K contributions and finally
- Stay calm, and be mentally prepared to expect market drawdowns that may rival the worst seen in the last 20 years!
Video/Book/Article/Audio for the Week
- Book: Recently came across the book, Black Edge, by Sheelah Kolhatkar and started reading. Black edge refers to the edge resulting from insider information about a firm, usually held in confidence, which if acted upon can have a clear positive or negative impact on firm’s stock price. This is a book about Steven Cohen and company, who made unheard of profits over the years exploiting the black edge.
- Article: Bloomberg article through 4-charts, showing just how irrational markets have become!
- Video: Frozen-2, yes its out on Disney+!!!