Brad and I thought it was a good time to send out a note of ours from 2020. We’ve updated some of the numbers, and a little of the verbiage, but the playbook is still the same. And the reason it’s the same is because human fear and greed are the only constants over differing market cycles. We’re all running the same software inside our heads.
This time IS different. They are ALL different. That’s how short-term thinking invades our long-term strategy and waves the proverbial carrot, making us think we can avoid the pain and only take part in the good times. If you find a way, please let us know.
Over the past 13 years, the S&P 500 is up about 500% (it’s closer to 600% if you include dividends). As impressive as the bull market has been, the relatively muted volatility, to me, has been the most impressive part. The reason it’s been so amazing was outlined succinctly by Tony Dwyer, Chief Market Strategist at Canaccord Genuity. He wrote that “in the real world, things generally fluctuate between ‘pretty good’ and ‘not so hot.’ But in the world of investing, perception often swings from ‘flawless’ to ‘hopeless’. What I can say is that four months ago, most people thought the macro outlook was uniformly favorable, and they had trouble thinking of a possible negative catalyst with a serious likelihood of materializing. And now the unimaginable catalyst is here and terrifying.”
Embracing the unknown and realizing that we won’t be able to pick the bottom is the first step, but regardless of the size of the decline, our playbook remains the same:
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- Extreme downside inevitably leads to a reflexive reaction to the upside due to market fear leading all investors to being on the same side of the boat. Given the vast amounts of negative news, there is an asymmetric risk/reward for good news, although we don’t know in what form this will take. In February 2016, it was something as simple as a vote of confidence from the CEO of one of the largest banks in the world, Jamie Dimon (known in the financial world as the Dimon bottom). In November of 2008, it was Warren Buffett making a large investment in Bank of America to give America the confidence to do the same (even though the market didn’t bottom until March of 2009). What will it be this year? We will only know in retrospect.
- The reflexive rally will likely only go high enough to burn off the fearful/oversold condition, not to repair the entire damage. Per our blog post on March 9th, 2020, we continue to expect a reflexive rally to lessen the fear in the marketplace. We anticipate this rally to be in the magnitude of 10%-15%. For reference, a 10% rally will take us back to around 4400 on the S&P 500. The idea that this will be a “V-shaped recovery”, similar to Q4 2018 and March 2020 is unlikely in our opinion. During that period of time, the market was reacting to one specific issue, interest rates. Once Federal Reserve chair Jay Powell did a 180 degree about face in December of 2018, the market did the same. The current crisis will be filled with uncertainty for some time. When will we start to see inflation peak, and inevitably subside? When will Americans have the confidence to freely move about the country and the rest of the world? How will these events affect the numbers of corporate America, and in turn, the economy overall? Will the paradigm lead to a further transformation for corporations and lead to greater opportunities (telemedicine, cloud-based workstations, e-commerce options)? These are questions we will not have clarity on for some time.
- In order to be reactive, we rebalance and/or add to equities if you’re able to do so, as the market retests the oversold low. Our process here at Second Level Capital is a systematic one, exactly for times like these. There will be a time and place to reassess everyone’s emotional capacity, but now is not the time to panic or change your strategy. If you started the year at a 70/30 (stock to bond) allocation, your account is down somewhere between 15%-20%. When we go to rebalance your account in the coming days/weeks, the process dictates taking cash (or bonds) and buying more equities to get your portfolio positioned to take advantage when times are better. Having a system in place that takes the emotion out of this decision is the only way anyone would ever do it. If I took a poll of clients right now who are chomping at the bit to put more money in stocks, I don’t think I’d get too many takers, although it has proven over time to be the prudent action.
The pain over the past four months has been unprecedented by many different metrics. But I’ll leave you with a quote attributed to Morgan Housel (one of the greatest financial writers of our time), who said,
“There are only 3 edges in the market:
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- You can be smarter than everyone else
- You can be luckier than everyone else
- You can be more patient than everyone else
What’s your edge right here, right now?”
We’re here to chat with anyone who needs a confident voice because we’ve been here before, and came out stronger on the other end. I believe we will again.
– Adam