With the sad news of the coronavirus spreading worldwide, I wanted to communicate some views and provide some perspective that I hope will be helpful.
Please make no mistake, this is a sad development and I do not intend in any way whatsoever to minimize the human toll and natural emotional reaction to these types of epidemics. I genuinely hope that nobody reading this note will have to endure the virus personally or through any loved ones. And I speak for everyone in our offices when I say that our hearts go out to those who have been affected. Further, our collective fingers are crossed for modern science to quickly find a solution.
Specifically today I want to address the potential economic impact of the epidemic and how that might play out in the investment markets.
Clearly it is a negative force. What nobody knows is exactly how long the negative force may last. With the virus now impacting the way people are behaving on a day to day basis, real economic impacts are starting to be seen. Some simple examples are that France is reporting tourism has dropped by as much as 40% and domestic restaurant operators are starting to note lower volumes. Beyond these types of visible impacts, the hidden concerns are growing as well. It’s logical to wonder how the supply chains for common consumer goods might be impacted when you think about how much manufacturing still happens in hard hit places like China and South Korea. What does this mean for both the availability and pricing of so many things we find in the stores?
And what does this all mean for the prices of stocks?
The stock markets worldwide came into 2020 riding a wave of momentum. Thankfully things hadn’t reached a euphoric state, but wide-eye optimism was starting to show up. That’s a dangerous thing, especially in light of the fact that I haven’t seen any evidence to believe that the speed of our trusty Plow Horse economy was picking up. So this momentum was more the result of a fear of missing out on future gains than a fair assessment of the fundamental value of the stock markets themselves.
This means markets are ripe for quick declines. Almost any time sentiment starts to run too high, the markets slip and speculators get hurt. But these are typically quick dips and the meaningful pain is limited to speculative traders and doesn’t spread to more serious investors.
It is extremely important to note that each of these dips have a scapegoat. And that scapegoat is typically a temporary punching bag that isn’t in the news in the months to follow. But when it is in the news, it is extremely scary. Add to this the notion that what passes as news, especially in the financial realm, is programmed to hit emotional buttons and it makes staying focused on longer term goals quite challenging.
Since the current scapegoat is a fast moving disease, I wanted to remind us all of how the markets have reacted to such epidemics in the past.
As you might expect, the initial impact is fast, furious and indiscriminant. And this last point is important to remember – that the benefits of diversification aren’t reaped in real-time. In other words, it usually takes a while before the natural decoupling of truly different asset classes occurs. This is due to the very nature of panic. Short minded people who are selling are typically so frightened that they sell everything, quickly. But when the initial emotional wave passes, diversification wins. So don’t be alarmed if you temporarily see two or more assets that legitimately have nothing in common behaving similarly. This is happening because for a very short while they have one very important thing in common and that is that there are more sellers than buyers active at the moment.
Turning back to the discussion about how markets fare during epidemics we can look at unfortunate events like SARS in 2003, Avian flu in 2006, MERS in 2013, Ebola in 2014, and Zika in 2016 and see similar patterns. After the initial downdraft, stocks have tended to be very resilient. When you look back on a chart of the markets it becomes very difficult to even spot when those events occurred.
As investors, we are constantly faced with the nature of markets to rise gradually and dip swiftly. This doesn’t mean anything is wrong, and it isn’t anything new. This has always been the nature of the stock market. It links directly with the nature of humans on the whole which is that we tend to fear the negative implications of bad things more than we anticipate celebrating the joys of good things. Said another way, we react more dramatically to negative stimuli than positive stimuli and it is this very phenomenon that results in most investors having a difficult time seeing their portfolio achieve the goals they’d set for it.
Remember that long term stock charts look a lot like the teeth of a saw. All those little teeth are designed to do a lot of cutting, and those same ‘teeth’ that show up in stock charts have a way of cutting more deeply into portfolios than they should.
Remember, too, that we humans respond strongly to both fear and greed; but much more to fear.
If you find yourself thinking something like “it makes sense to me that we could see a global virus spreading through major economies, impacting travel plans and supply chains, and reducing overall confidence levels for a while; and along with this we would see stock prices temporarily correct”, then you’re thinking is right in line with that of most people. The good news is that history is on your side to hold this view. The bad news is that it suggests stock prices haven’t finished going down since the classic definition of a correction is a dip of 10% and as of this writing we’re only 5% from the peak. So it might require a little more of a stiff upper lip in the coming weeks before this storm passes.
So what should be done with a portfolio at a time like this? In the vast majority of cases, not much, if anything. The late Jack Bogle, founder of Vanguard, loved the saying “don’t just do something, stand there.” Well, I don’t suggest going so far as to just ‘stand there’ and take it on the chin as a standard course of action. But where this wisdom applies is that we need to be mindful that perfection is often the enemy; meaning the quest to find the top and bottom pivot points of the financial markets is a path to ruin. Instead, it’s better to be diversified and disciplined. If you start with assets that have the customary zig/zag relationship and you stick with a solid exit strategy for your holdings, you will be far better positioned to control any emotions that might creep in and have you do something that might feel good for the moment but turn out to be painful in the full measure of time.
Incidentally, I found it ironic to see Warren Buffett, perhaps the King of long term thinking, being interviewed and fielding questions about the Berkshire Hathaway annual meeting and his letter to shareholders with this sad coronavirus situation as the backdrop.
Based on his need to never use any of his wealth in his lifetime, Buffett’s attitude can clearly be different than the rest of ours; but some of his pearls of wisdom are universal, just as they have been for decades. Suffice to say, seeing stocks dip a handful of percentage points quickly is something he’s seen many, many times. His input was very clear that this storm cloud is both real and passing. He’s not intending to do any selling or buying in the face of this he said. But he was very clear that his next move is far more likely to be to buy than sell.
In my view, it’s too soon to make any significant financial or investment decisions in this current correction. Something always comes along to shake confidence from time to time. Just last month we had a really bad day in the markets on concerns about Iran. Now that concern has been magnified as it shifts to coronavirus and its influence on the global economy. This might not be a ‘garden variety’ correction, and it’s far too soon to know.
What we do know is that the market rose to a point of being particularly vulnerable to a needed correction. The probability is that this is a necessary correction in an ongoing upward market and not the beginning of a bear market. This is a logical reaction to a fundamental shift in the landscape and is likely to keep the Federal Reserve in a supportive stance even longer. So while the markets will slip a bit and economic growth will continue to side with the Plow Horse and not the Race Horse, the odds that this is a large enough issue to cause a recession are low.
The Takeaways:
- Every correction needs a scapegoat. That scapegoat is always a truly unique thing that brings with it untold economic damage. Or so it would seem.
- I don’t intend to be insensitive or to downplay the sadness of such an epidemic and I don’t want to act as if it doesn’t have a genuine economic impact either. At a time when sensationalism prevails, it is very important to keep things in their proper perspective.
- Remember that the benefits of diversification don’t show up in real time. Panicky sellers sell everything and all assets face an immediate wave of selling, but decoupling most certainly happens. This being said, if you find yourself struggling with your comfort level during a time like this, we should have a conversation about risk profiles and long term goals. Your assets have been saved to ultimately bring you more comfort in your life, not more stress.
- Along those lines, one of my favorite things to note is how in the real world of our everyday lives things tend to swing in our minds between ‘pretty good’ and ‘not so good’, but in the investment world they foolishly swing between ‘flawless’ and ‘hopeless’. The markets were starting to strike a tone of flawlessness and it is now battling a sense of hopelessness. A lot of optimism is being drained from the markets. Counterintuitively, this is a good thing. Investors with a multi-year time horizon should accept these jitters as the emotional tax we all pay to earn better returns on our money over time.
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