Excerpted from a letter to clients written the evening of March 12, 2020. Anyone can sign up for our quarterly updates here.
We'd first like to express our concern for the health of our clients, families, and friends. The situation has escalated and we know that this is a very concerning time on a number of fronts.
There is nothing we want more than to do the right thing during this time and wind up in good shape in the end for our clients and ourselves. (Our personal portfolios are invested right alongside yours in all of the same investments).
As the markets have continued the rapid decline into bear market territory, we wanted to provide you with an update on what we're thinking and how we're managing your portfolios through this.
Learning from past panics
For a little personal perspective, we were remembering back to the craziness of the Global Financial Crisis in October of 2008. At that time, markets were dropping 5-10% per day, too. The feeling of panic and uncertainty was very similar to what we're feeling and seeing this week.
During those difficult days, despite the sick feeling in our stomachs, we started adding exposure to stocks. It wasn't easy, but we didn't think the crisis was going to result in the end of the world's economies and we knew that remaining calm and buying into panics is what long-term investors have historically benefited from. The markets bounced back a bit, but then continued to decline into March of 2009. We felt the pain of our increased exposure the whole way down, but eventually, we were well rewarded for it.
On the other hand, investors who sold out in October 2008 were generally feeling smart for a while, but most were left behind when markets eventually went up. They might have avoided some of the decline in the short term, but they were the ones who were truly harmed when all was said and done.
It's also instructive to look at the stock market bottom, which took place on March 9, 2009. There was no economic news of note that day. The outlook didn't suddenly brighten. Stocks simply stopped going down, and started going up. Three months later, the global stock market was already up almost 50%, and it continued upward from there.(1) People who had been on the sidelines waiting for the "all clear" signal never had a chance.
Current outlook and portfolio approach
The COVID-19 pandemic is already having serious short-term economic effects, but it still appears very unlikely that it will result in a significant, lasting impact on the fair value of our investments.
The pandemic could cause a recession — perhaps one is already underway. But recessions happen. They are part of the economic landscape, and the fact that they occasionally occur is already accounted for in fair value estimations.
The nature of recessions is that they are temporary, and that seems especially likely in this case.(2) A temporary slowdown in economic activity, even a significant one, just doesn't add up to all that much when combined with the long-term stream of earnings that stocks represent. And yet — the world stock market is down over 27% in a single month.(3)
This appears to be a serious overreaction. As we did in 2008, we are trying to take advantage by slowly increasing stock exposure and steadily rebalancing into the panic.
Also like in 2008, we don't know how this will play out in the short term. But we think it's very likely that in 3 or 5 or 7 years from now, we'll look back at this period as having been a great time to be buying.
Even now, we still have room to add more stock exposure in our models. If markets decline further, we will consider the opportunity to buy more at even better valuations.
If, on the other hand, the decline quickly comes to an end, we will be glad we got the chance to add when we did.
Risk tolerance in an abnormal market
The idea that financial market downturns can be reliably avoided, short of staying out of markets altogether, is wishful thinking. We don't expect to avoid them or for them to be easy to endure. We only expect that we will all be able to tolerate them and be willing to take advantage of them if we can. That is why we focus so much on risk profiling and on getting clients into portfolios that are appropriate for them.
This downturn has definitely become a serious risk tolerance test. We just had the worst single stock market day in over 30 years, and we've never before dropped so far, so fast, from a market high as we have this past month. The markets have been way out of the normal range of volatility, and, as a result, our own portfolios' volatility has been too.
With that said, all of our clients' portfolios are down less than the stock markets, with all but the most aggressive investors down substantially less.
We know it's not a lot of comfort to be down less than the market when the market is down so much. But it's important to understand that the portfolios are performing as we'd expect in such circumstances. And, importantly, we have some non-stock investments that have held up relatively well if anyone needs to withdraw money before stocks bounce back.
We realize that this is a very stressful time for many of you. If that is the case for you, try not to focus on tomorrow or next week, but instead on the months or years ahead when this will all be behind us. In the meantime, know that we're doing everything we can to make the most of this situation.
A few other thoughts
- If you ever thought about increasing your stock exposure, and you've been able to tolerate the past few weeks fairly well, then that's a good sign that changing to a higher-growth model might be suitable for you. If that's the case, this is probably a good time for it. Let us know if you'd like to discuss it with us.
- Even in serious bear markets, it's typically the case that those who stay the course end up doing fine. The biggest exception is for investors who have bought into bubbles. Owning tech stocks in 2000 or mortgage companies in 2007 was not rewarded for a long time, if ever. Fortunately, our value-focused approach is designed to avoid the bubbles and similarly overpriced investments. We have a very diversified mix of global stocks that are fundamentally sound and reasonably valued (now undervalued, in many cases), as well as various non-stock investments. Investments like these are the kind that tend to bounce back once the panic phase is over. But for those investments that started out very expensive, the recovery may be a lot slower.
- Recent market activity has many of the hallmarks of a liquidity crunch, in which some investors are forced to sell their holdings at any price. There are a couple positive aspects to this. First, liquidity crunches can sometimes end quickly once liquidity is restored. (Contrast this with a bursting bubble, for instance, which could take years to unwind). Second, they can be great opportunities for investors who are willing to provide liquidity. This is exactly what we've been doing, getting fire sale prices on good investments that other people have been forced to sell.
- Slightly off topic, but: refinance your mortgage if you can! Interest rates have plummeted, and while the panic may be temporary, the rates you lock in for 30 years won't be. We can recommend a good loan broker if you don't know one.
We'll close by noting that we still feel that this is the best opportunity for value investors in 20 years. Since we wrote about that idea in October, the medium-term outlook hasn't changed that much, but valuations have dropped hard and future return estimates have increased dramatically. It's a situation that's hard to endure right now, but in the end it could even turn out to be a positive for our long-term investment returns. In the meantime, we will do our best and hope that the pandemic is resolved quickly and with as little human suffering as possible.
Please stay safe and let us know if you need anything.
1 - Source: stockcharts.com (ticker VT, Vanguard Total World Stock Market)
2 - The virus scare seems like it could be fairly short-term. At some point, it will be contained or brought under control -- as is already happening in some countries -- or everyone will have gotten it (that's without considering sooner-than-hoped-for advances in treatment). A recession caused by an exogenous, one-time event is likely to be shorter than one caused by (say) a banking crisis, bursting bubble, or misalignment of the real economy. Additionally, the globally synchronized nature of the virus threat could result in a coordinated fiscal and monetary stimulus like we haven't seen since the financial crisis, which would certainly provide a boost. So there are several reasons to think that any recession we have could be relatively brief, especially compared to that which accompanied the Global Financial Crisis.
3 - Source: stockcharts.com (ticker VT, Vanguard Total World Stock Market)