March 20, 2020
Black Swan Event
As it relates to the markets, this is a classic “Black Swan Event”, which is an occurrence that happens without warning, could not have been predicted, and typically has an immediate and intense negative impact. What we know is that this virus spreads extremely quickly and the most impactful measure we have is for affected areas to literally shut down and have individuals isolate. Areas in this case are measured in countries, hence the massive impact we are seeing economically.
The engine of our global economy runs based on industry production and distribution as well as individual’s spending. When industry is shut down and consumers do not spend, it puts the brakes on the economy. In this case of shutting down entire countries, it is more like turning the engine completely off. The results to date are approximately a 30% drop in the S&P 500 and significant volatility in the markets. This is also a highly emotional event that has an effect all of us. Could the markets go lower? Yes. How much lower? That we do not know, but we will touch on what to do, shortly.
Currently, slowing the spread is what is most critical via “Social Distancing” and here’s why. Social distancing is really about compounding math, or stopping the compounding. As we write this, the US has about 15,000 cases and only 1% recovery, while the number of cases is doubling every two days. At our current pace over the next two weeks the number of cases would double around six times. Let us help with the math: (1) 30,000 cases (2) 60,000 cases (3) 120,000 cases (4) 240,000 cases (5) 480,000 cases (6) 960,000 cases. So please expect the government to invoke more stringent orders around social distance, and please join us in practicing them.
Some Good News
The virus started in the Hubei Province of China (Wuhan) approximately three months ago. China has reported about 80,000 cases. Yesterday, China announced there were no new cases and their recovery rate is now around 88%. This is good news in that it begins to provide a time frame. The wheels of the economic engine in Wuhan are now starting to turn as people begin moving about, stores are beginning to reopen, and workers are returning to their jobs. In fact, according to NPR, about 80% of economic activity is now occurring. Europe and the US are about eight to ten weeks behind Wuhan.
Given that back drop, clearly Q1 will be a quarter of negative returns and no meaningful growth. It is also very likely that we continue to see significant market volatility for a while as Europe and the US move through the curve of significant increase in new cases, to a plateau, to high recovery rates, and finally little to no new cases. Once we reach that point, we are very confident the wheels of the economy will start to turn. As businesses reopen, production will increase and people will begin to spend again.
While we don’t know if the markets will go lower, many feel as though the markets have been oversold, which is often the case when we have seen major corrections in the past. For our clients who are already invested, we are strongly encouraging them to stay invested. Our portfolios are built with the assumption that there will be corrections in the market. Hence the number of various asset classes, and levels of diversification we have in place. At some point, once the wheels of the economy begin turning, we will see recovery. While recovery time frame is unknown, whether it takes three months, three quarters, or three years, it will happen. When it does, our clients’ portfolio’s will recover as well. There is some speculation that once we are through this initial phase we could see a quick bounce up in both the markets and the rate of recovery, as there is nothing fundamentally wrong with the economy; it has artificially been shut-off. Rest assured, during this time period, we will make adjustments as needed to our portfolios.
Strategic Buying Opportunity
Given the markets are off about 30%, this presents a real buying opportunity. Money invested today will yield a return of just over 40% when the markets recover. So even if it takes a number of years to recover, that’s a fantastic rate of return. Below are some strategic ways to invest, please leverage our team to facilitate this for you.
- Consider adding excess cash to your investments. If you have an excess of $10k+ that is sitting in a bank account or in a money market fund, now is a very smart time to invest. Depending on the amount that you would like to invest, we will recommend that you either invest now while the market has pulled back, or invest incrementally for larger amounts to allow for buying at various rates of the dips.
- Re-optimize your 401k. Have a 401k that is conservative or moderate? Consider reallocating to a greater equity allocation while the markets are lowering in value to capture recovery. Once recovered, we can look at your allocation together to determine a good time to adjust back to a lower equity weighting.