The past few weeks have been a wild roller coaster ride in the markets. Clients’ accounts have lost enough market value that they are scared. As financial advisors and fiduciaries, we want to protect our clients from more carnage, but we also want to try to repair the damage to their portfolios.

However, a word of caution before you jump back in the water and “load the boat” with new investments. Remember that we arrived at this point due to uncertainty, specifically the uncertain economic impact of the coronavirus (COVID-19). As advisors we know that investment markets hate uncertainty, and we are facing more uncertainty now than any time in recent history. Not only do we need to watch for this virus’ curve to flatten, but there are other variables that need to be considered before we get some clarity. 

In addition to the virus’s growth curve, I would suggest that we watch at least three things: 

One is weekly unemployment numbers. Expect these numbers to climb much higher than the 6.6 million claims that were filed the week of April 2. The rationale is this: as of December 2019, more than 158 million people were employed in the U.S., so only 2% of the employed filed claims.  We know that significantly more than 2% of our jobs have been lost.  We must also consider how long these people will be without jobs.

A second item to watch oscredit markets. We knew that corporate debt was high as we came into this crisis, but the numbers bear a closer look. As of the end of 2019, corporate debt had ballooned to 47% of the overall economy. At that same point, Morgan Stanley had determined that more than 50% of investment grade debt was rated BBB-in other words, on the precipice of junk! That was the highest level since 1992. Also, the IMF has stated that almost 40% of companies will not be able to cover their interest payments in a recession. Thus, the longer that companies go without revenue, the larger the percentage that may have to default, even with fiscal stimulus. As more companies face insolvency, more people will lose their jobs and this recession may last longer than we initially thought. China’s lagging recovery from the virus currently shows us that this is a big probability.

The third item is what most of us are already accustomed to focusing on: Valuations. Some Wall Street strategists suggest that investments are now cheap – but how can we make that statement with so many unknowns? For example, P/E ratios are dependent on the “E” or earnings. Not only will forward earnings expectations for companies be taken down drastically when they report their first quarter earnings, but many may state that they have no idea what to expect for the second quarter or the rest of 2020. Only when these announcements are made can we determine what is cheap compared to historical averages.

What are the top five things you can do right now?

  • While we wait, create a shopping list of possible investments that you have considered buying in the past, but were too expensive.
  • Let your cash balances make money for you by investing it in a solid money market fund that has the lowest risk possible. Government money market mutual funds only invest in U.S. Treasury securities and repurchase agreements collateralized by U.S. Treasury securities. Currently, yields for these range from 1.2-1.45%
  • If you believe that future equity downside is greater than 10-15%, consider using hedged equity products that can reduce your clients’ participation. Bear markets result in an average pullback of 42%. As of March 27th, the S&P 500 was only down 21%.  Couple this with that fact that a bear market’s average duration is 22 months. The Coronavirus has resulted in a financial crisis that is unprecedented. We don’t know how much this will cost the U.S.’s economy and its citizens, nor its duration. The more you mitigate your portfolio's downside, the less you need to recover before you continue to build on their capital.
  • Look at buying high-yield debt, but average-in. You may have a few buying opportunities. While interest rate spreads haven’t been this wide since 2009, they may get wider. MSCI anticipates spreads to increase across all sectors before they normalize. A record number of defaults in bonds are expected.  However, high-yield markets tend to bottom well before defaults reach a top. Stay away from sectors that are expected to be especially hard-hit, including energy and leisure. 
  • Now is the time to start evaluating growth stock allocations in your portfolios. Start with large cap growth, and then add small cap growth. Companies within a large cap index are typically profitable, have lower debt to equity ratios than small cap companies, and still have price-to-earnings ratios lower than their 20-year averages. Look for sectors that will continue to thrive in a recession and/or help the economy rebuild, such as technology and healthcare. Now is the opportunity to own some solid names that up until recently were too expensive to justify.

My recommendation is to wade in or dollar-cost average in with most of the above suggestions. Bear markets can be very volatile and you will have many opportunities to buy investments that will perform well when the economy improves. The upside of the markets will come way before clarity does.

About the Author
Michelle Connell, CFA, owns Portia Capital Management, a Fort Worth, Texas-based RIA specializing in the investments of foundations, charities and high net worth individuals.

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