Setting The Stage
• An elevated fear level exists, driven by economic uncertainty caused by the global coronavirus outbreak.
• The Federal Reserve has announced two emergency rate cuts in an attempt to stabilize the markets, but these did not act as a stopgap for long. Rather, the rapid worldwide spread of coronavirus and the potential long-term economic impact have sent the markets into a tailspin. A lower interest rate policy may support accommodative financial conditions that could help to sustain household and business confidence.
• The Dow 30 and S&P 500 have now fallen into a bear market for the first time since 2008, and the past several weeks count among the most volatile in recent history. The broadening pandemic has led to a global “risk-off” sentiment.
• U.S. interest rates across the yield curve have moved substantially lower and long-term rates have fallen to uncharted low levels, reflecting an ongoing “flight to quality” as nervous investors rotate away from equities and into U.S. Treasury bonds.
• In the short-term, we believe the odds of a U.S. recession (six months of negative GDP growth) have increased. The depth of the economic downturn ahead is extremely hard to predict, but could be severe for a short period of time.
• As the coronavirus containment visibly improves, we expect economic activity to resume and gradually move back to normalized levels.
What Should Advisors Do?
As the world practices self-quarantining and social distancing, most find themselves working remotely and simultaneously watching or listening to the news and social media. The combination of this extreme disruption, deluge of commentary and social isolation is amplifying emotions, which can cloud sound judgment and decision-making, particularly when it comes to one’s finances. Panic can lead to clients making hasty, emotional decisions, and it’s important to not let the coronavirus infect financial plans.
So what is the antidote? Clients should limit their news intake and perhaps even turn off the TV, radio and instant messaging devices. This is not to suggest that they should bury their heads in the sand and ignore what’s happening in the world, but to limit it to ensure that balanced and rational thought is driving one’s actions rather than fear.
One client emailed at 8:30 p.m. with instructions to “sell everything and go to cash.” He is in his 70s and retired within the past two years. The following morning, we spoke to discuss his email and the rationale behind it. He admitted that the uncertainty of the coronavirus had him worried and he felt that he’d just be safer “on the sidelines.” We had prepared a comprehensive financial plan prior to his retirement and reminded him of the assumptions underlying that plan. First, he already had three years of anticipated living expenses out of the stock market in a reserve account. Second, his portfolio was generating about 70% of his annual living expenses each year through dividend and interest income, so his reserves were “replenishing” annually as well. However, due to the firehose of commentary he was hearing and watching, he had forgotten these facts. Realizing that we had planned for inevitable volatility and even modeled extreme possibilities, he was comforted and decided not to act impulsively on the headlines.
Volatility like we’re experiencing does create feelings of uneasiness and uncertainty, but it also potentially creates constructive portfolio rebalancing and upgrade opportunities. Depending on your clients’ allocations, it may be an opportune time for them to trim the overweight sectors to bolster the underweights. Diversification causes many sectors and asset classes to respond differently, and the “flight to safety” may have produced divergences from original allocation targets that could be trued up at this time.
Another constructive response to market volatility is to upgrade quality in your client’s portfolio. Rather than continuing to own investments that may have deteriorating outlooks, investors can upgrade holdings to keep them invested according to their targets but with an improved lineup.
Depending upon the investor’s time horizon and objectives, current volatility may be presenting buying opportunities. Dollar cost averaging, for example, is a systematic way that your client can continue to invest through periods of volatility.
Another retired client phoned with an “I’m worried and feel like I should do something” response to the market craziness. Again, we paused and referred to her written financial plan and target asset allocation for meeting her near- and longer-term goals. After reviewing her written plan, she too realized that her living expenses for several years were already reserved, so her advance planning had prepared her for this “emergency.” Still feeling the need to “do something,” we reviewed her current asset allocation versus targets, and we noted that her bonds had appreciated greatly in just the past month. Ultimately, to rebalance to her plan targets, we sold some of the overpriced bonds to buy some of the “in correction” equities.
Maintain Perspective
• Market volatility is certainly not a new phenomenon, and we have experienced numerous corrections and bear markets over the decades. As we have witnessed, markets can turn both up and down quickly.
• The stock market is a “look forward” and anticipatory mechanism. As such, as confidence returns and investor sentiment improves, it can turn quickly and long before any economic “all clear” signal sounds. In March 2009, we were still in the midst of a generational recession with companies going bankrupt, yet the stock market began going up and generally didn’t look back for over a decade.
• Corrections and bear markets are a reality of investing, not the end of it. History shows unmistakably that we have recovered from every past correction and downturn only to eventually mark new highs in the market. Over the long term, the upward direction of the S&P 500 index is unmistakable.
It is understandable that in times of uncertainty, clients might question themselves and the assumptions they’ve made in their investment plans. Reminding clients to temporarily turn off the news to make a reasoned and balanced assessment of one’s financial plan and potential adjustments or improvements to it, in light of market conditions, is a healthy antidote.
Andrew Crowell is vice chairman of wealth management at D.A. Davidson. James Ragan is director of wealth management research D.A. Davidson.