Markets globally are recovering more rapidly than you might expect after reading about today’s new Coronavirus deaths or how unemployment figures in the U.S are hitting record highs.
Over the past two months, we’ve all experienced a roller-coaster of emotions—especially fear. First, the media reminds us daily of a contagious virus that could infect and kill you or your family with a new death tally. Then state government mandates keep millions at home and keeps millions of citizens from working at their jobs.
Many Americans worry how to pay rent and bills. A little CARES money from the IRS won’t help most of them. And for those near or at retirement, planning a comfortable lifestyle from portfolios that gradually grew over the past decade, now worry about what will happen. Moreover there are grieving families of those who got sick and died.
MARKET PRICES ARE FORWARD-LOOKING
Financial marketplaces like the New York Stock Exchange can be leading indicators of U.S. economic health. Share prices on exchanges around the world are rising again this week. That is not an indicator of imminent doom. Continued recovery of markets from their lows implies that the savviest investors — including institutional traders whose algorithms dominate trading — believe that early virus risks were overstated, and that an apocalyptic outcome will not occur. That does not mean that there are no other important investing risks around.
Market prices of publicly traded stocks and other securities aggregate all available information — not just the news sensationalized by the media. Markets prices incorporate a collective “best estimate” of how soon states will reopen for business and Americans resume their normal lives. Opinions about how much “stimulus” of government spending will, in fact, stimulate American business are incorporated in prices. That is another big risk markets have uncertainty pricing.
For us at Professional Financial, it is a fundamental principle of investing that modern capital markets continually process new information in the form of prices. Information processing through prices occurs almost instantly as markets decline and when they rise. Sharp price declines distress investors, but even large unexpected changes are evidence that markets are functioning properly during a perceived crisis.
Market declines occur when investors, collectively, are forced to reassess their future expectations for earnings that companies, represented by those shares, may generate. What made the Coronavirus so terrifying to investors was the media’s sensationalized death forecasts that ignored the reasonableness of the assumptions underlying those models. Immediately after the gargantuan CARES Act was passed, updated models gave radically new forecasts with outcomes only 5% of earlier worst-case scenarios.
PRICES REFLECT POSITIVE EXPECTED RETURNS
Our investing strategy is based on the principle that markets price securities to deliver positive expected returns. Markets, as vast information procession “machines,” evaluate a constant flow of information as each participant judges individually the impact of new information on future outcomes of various businesses. Prices may adjust wildly during times of heightened uncertainty — such as how fast and far a deadly contagious virus will spread or be allowed to spread. When perceived risks increase due to newly discovered information, that news is quickly incorporated into prices as investors then pay less for shares.
As market participants collectively gain certainty about the impact on future company profits in general — say, observing how governments are attempting to ameliorate the human and business costs of shutting the economy down — perceptions about risk begin to ebb. Prices of stocks one by one stop declining and then begin to reverse, in fits and starts, collectively precipitating a rally like we are seeing. Even though the media today displays infected people dying, market participants have a different picture of tomorrow.
INFORMED INVESTING AND SUCCESSFUL STRATEGY
Disentangling emotions from investment management is essential. Bombardment daily and hourly from negative media news plays havoc with our emotion. It clouds rational thinking. There is no reliable way known to identify a market bottom, much less a peak. Emotion commotion should not infect your investing decisions. If you over-react and get out, how do you ever decide when it’s “safe enough” to get back in?
We can’t be sure if market rises of the last few weeks won’t be followed by a short decline. Eventually, in the years ahead, there will be another big market decline triggered by events we cannot predict. But our expectation is that clients positioned in dimensionally-targeted strategies will be well-compensated with higher positive expected returns that help them better realize key retirement and legacy goals. Those who fearfully sell shares in panic when negative news overwhelms their emotions will be rewarded only with regret.
AN OPPORTUNITY FOR REWARDING DISCIPLINED INVESTORS
What so many see as a crisis, we see as a tremendous opportunity for our clients as well as ourselves.
Our planning philosophy expects bad things to happen unexpectedly. Markets are volatile. Since, by definition, a panic is “unexpected,” we cannot predict when it will happen or how much volatility there will be. But in recent years large growth stocks around the world, but especially in the U.S., have reached historically ridiculous valuations. In fact, at year-end expected returns of U.S. growth stocks had been trading down to those of investment grade bonds.
Value and small stocks around the world have been hit badly — but that’s good news for the informed investor. Expected returns are not just higher — they are much higher due to panic liquidity selling on the long, painful and ugly decline. In phases we bought into discounted positions through Dimensional Fund Advisors all the way down. Our investment management process systematically buys into falling prices to rebalance, not knowing when the bottom would occur.
Repeat the investor’s mantra: The company’s cost of capital is my return. Repeat again. Breathe and relax.
When prices go down, that means the cost of capital is going up. That means, your expected return for planning purposes is higher. When highly leveraged hedge funds are desperate for cash to pay their loans, your purchase helps them — for a price. Crisis is a rewarding opportunity for liquidity providers (you!) with time to wait it out.
Based on decades of leading theory and research, we prepared with a crisis in mind when we designed your strategies and had a process arranged for such an event. I dream of and dread these times. But our planning appears to have worked well.
What now matters most for long-term success in investment planning, if you feel the need to take action, is to stay focused on those things you can control. The most important thing you can do today, is to control your actions.
Don’t have a crisis of confidence. You’ve endured a lot of risk these last two months; I urge you to stick around and wait for your return.
Better yet, forget about your portfolio — you pay us to worry. Once a quarter is enough for most of you.
Enjoy being with those you love. Even before stay-in-place restrictions lift, turn off your news media access. Think about what most matters to you and what most gives you purpose. Prioritize your life and start living.
At the very least, certainly after a long winter, get out of the house and enjoy spring. You only live once.
We are here for you, 24/7 for a conversation. Call or email us with your questions and concerns.
Warm regards, and God bless – Paul