Let me begin by saying that yes, I am worried about Coronavirus and the markets. I can understand any anxiety that it is causing any of you. I want to take a few minutes to address fears and create some understanding. I’ll talk about fear mongering in the news, how our clients are positioned, and say a few things about Coronavirus in general.
Fear Mongering
When the market drops like it did today, the news media goes haywire with headlines like “Dow loses 1000 points.” If you’ve read any of my newsletters or insights during previous steep one-day declines, you’ll recognize this statement: “We should only quote gains and losses in percentages.” And, you’ll also recall that I always warn that the Dow Jones Industrial Average is the wrong indicator for how markets are performing overall. “The Dow” only includes 30 very large companies, and they’re the ones with the most international exposure. Other stock indices include hundreds or thousands of companies, and just about any of them would be better to reference than the Dow. And yet, news outlets like to use the Dow anyway. Why? Because Dow losses equal bigger points losses. The Dow started the day near 29,000. So, a -3.56% drop is a loss of 1,031 points. The S&P 500 started the day at about 3,334 and had a -3.35% drop, which is a loss of only 112 points. 1,000 points is much more exciting as an attention-grabbing number in a headline. If you want to take it further, the Russell 2000 (Yes, 2000 companies in that one) started the day at about 1,690 and dropped -3.01% which is a loss of about 50 points. If the headline instead read “Russell 2000 loses 50 points” you probably wouldn’t open the article. I think most of my clients would say “What’s the Russell 2000?”
In the same way that we look at points, we should also look at dollars, because that’s really what they are after all–a representation of value in a multiple of US Dollars. Percentage losses are much more important to consider. Yes, when I looked at my assets under management today I saw that my assets under management (the total value of all the money I manage for clients) were down hundreds of thousands of dollars. That dollar figure stings. But, when I look at the percentage . . . my assets under management were down -1.38%, not -3.56% like the Dow, and also not -3.01% like the Russell 2000. Individual losses for clients may have been less than or greater than the -1.38% depending on which investment model is assigned to the client, and how much stock exposure that the client has as a result. More on that later. Let’s continue with the bigger picture of markets as a whole.
Stock market returns are never a straight line from point A to point B. The market is a rollercoaster. Sometimes it goes down for no real reason. A headline will give a reason, but often no one actually knows. Sometimes it goes down because of end-of-year tax-loss or -gain harvesting. Sometimes it goes down for a legitimate reason. Sometimes it goes down just because it’s overheated and needs to cool off. Coronavirus is a legitimate reason, though we don’t know what will happen. At this point, people can only guess. The market is pricing in what it anticipates could happen as a result of Coronavirus. The market also went down when Britain first announced it was going to exit the EU several years ago–way in advance of it actually happening. This is what we mean when the anticipated outcome actually occurs and we say “it was already priced into the market.” Despite the short term fluctuations, the market can still have positive returns at the end of the year. Here’s a chart from JP Morgan Asset Management’s Guide to the Markets (If you know me, you know that I sometimes carry a hard copy of this in my purse in case I need it). It illustrates annual returns and the actual drawdown in the middle of the year for the S&P 500. For example, in 2019 the worst drawdown was -7% but the market ended up 29% positive for the year, and in 2018 the drawdown was 20% but the market was only down -6%. Intra-year declines are normal and happen for a variety of reasons.
Every year in our history there has been some event that could have thrown the US, or even the entire global, into a recession or depression depending on the final outcome. We’ve gone through wars, credit crises, tsunamis, nuclear meltdowns, high unemployment, terrorist attacks . . . and yet, we’re still here and over time the markets have continued to gain. It’s important to remember that this never happens in a straight line.
How Our Clients Are Positioned
When each of our clients comes on board we collect data through both conversation and questionnaires to determine the suitability of our investment recommendations. We look at overall goals, risk tolerance, how long the money is going to be invested, whether or not the client requires income, and if the client has adequate savings or liquidity outside of their investments. That helps us align the client with an investment model that meets a goal: income, growth, or both; and is within a specific risk tolerance metric, ranging from conservative to aggressive. We do that because we want to make sure our clients are positioned appropriately in times like these. That’s also why we meet with clients in person or over the phone at least once a year to discuss and ensure that the client still has the same conditions for investing as they did when we first began. If things change for the client and the client comes to us, or if we notice significant changes in the way the client is using their accounts, we take action to change the risk metrics of the account and we talk to the client about why the changes have occurred and if they are temporary changes or more permanent or ongoing changes.
If a client is invested in a moderately aggressive or aggressive model, then the client should expect to lose with the market. That’s part of the risk-reward trade-off. Selling when the investments are down will only lock in losses. There’s an appropriate time for that, but for most of you, a short pullback is not the time to make the change in your accounts. If short term volatility and smaller intra-year losses bother you, then we need to have a discussion about changing the risk tolerance listed on your profile and moving you into a model with less risk and less stock exposure. It will limit your upside because less risk means less reward, but at least we can work together to find a “sleep-at-night” level for you while still working to achieve an acceptable level of return.
The closer you are on the risk tolerance spectrum to “Conservative” the less exposure you have to stock market volatility. Not sure which one you have? You might recognize one of these based on the descriptions.
- The Beanstalk (the all-stock model) is 100% stock and is the most aggressive. It’s only available to invest in accounts with at least $250,000 for clients that have a very high-risk tolerance, whose goal is growth, and who have a long time horizon and no liquidity needs. This stays in the market all the time no matter what the market does.
- The Cruiser is about 60% – 65% stock, depending on the month, and is considered a moderate risk tolerance model, but is optimized for high income. Selling means no income. So, this stays invested the way it is all the time and does not move above or below the 60% – 65% threshold. It’s only available to invest in accounts with at least $50,000.
- The Tactical Asset Allocation models have varying proportions of stocks and bonds based on risk tolerance. There’s conservative, moderately conservative, moderate, moderately aggressive, and aggressive. They also have built-in rules that result in pulling completely out of stocks if the rules are triggered. Sometimes they pick up precious metals. They do participate in some downside before moving out of stocks because we don’t want the whiplash of getting in and out. We want real confirmed downside momentum so that we don’t accidentally get out and miss a bunch of upside. These are only available in accounts with at least $50,000 (but we sometimes make exceptions to the minimum on these models).
- The State Street Exchange Traded Fund models are risk-tolerance-based. Those are used in smaller accounts until the client reaches a balance where we can invest the holdings in either a tactical model, or the Cruiser or Beanstalk. These don’t have any tactical movements but do have periodic rebalancing.
In a nutshell: All clients are in models based on discussions and data gathering about suitability and risk tolerance. The only models we have that get out of the market are the Tactical Asset Allocation models. They’re all still in, but if a rule is triggered, stock exposure will be reduced accordingly. If you are uncomfortable with a one day decline of more than 3% then you may be invested too aggressively and you should call or email to set up a time to discuss and make changes. We don’t want anyone out there stewing when it would be easy to just make a change. That’s what we’re here to do for you.
Coronavirus
Coronavirus is not new. This strain is new. The common cold is a coronavirus, and so were SARS and MERS. The new strain has been named Covid-19. There’s a lot of speculation and some conspiracy theories circulating about the source of the new strain, but that kind of speculation is a useless waste of energy (but it’s kind of entertaining to read the speculation). It’s more important to consider what will happen now that it is undoubtedly here.
One area of speculation that I do think is worthwhile is the potential number of cases. As of writing, news outlets were all reporting just under 80,000 confirmed cases worldwide. I think it’s important to focus on the word “confirmed.” Confirmed means there was a positive test. This virus was brewing in China for at least a month before it became a headline, maybe longer. Also, it is asymptomatic for at least two weeks, during which time, a carrier has no idea that they’re infected; and apparently, people with no symptoms can transmit the disease. People were traveling and infecting other people long before quarantines of whole cities or cruise ships. I think we’re only seeing confirmed cases coming from places that have the medical ability to make the confirmation, and mostly among people whose symptoms advance beyond what one would experience with a bad cold, which prompts them to go to the doctor or a hospital. Chinese commerce and industry take place all over the world, with massive operations in mining and other industries in Africa. They travel abroad to countries in the Middle East, Asia, Australasia, and the Americas. It’s highly likely that the virus is already widespread in many countries that are not reporting simply because they don’t have the means to confirm the cases. At this point, any of us could get it at any time and from anyone, not just someone traveling from China, and global cases are probably already out of control. It is highly contagious.
Once symptoms show up Covid-19 presents as a bad cold for most people. It seems to kill at a rate of about 2% among reported cases, and most (but not all) of those deaths are people with compromised immune responses. It kills by causing severe viral pneumonia.
Why would it make the stock market drop? The market does price in anticipated outcomes. People get out because they think something bad will happen as a result of the virus, but they don’t know. I will tell you that, based on volume today, it was small money making the market drop: people trading on their phones or home computers, not big money managers. The big money will probably stay out of the way while small traders run the prices down. Then they’ll jump in and start buying. I don’t know when they’ll jump in, but after low volume but steep price declines that’s usually what happens. And, as I write, futures for tomorrow are positive. So we’ll see what a night’s sleep will bring. The biggest issue from Covid-19 is its effect on the global supply chain, and the evidence is very clear that the issue will leave a mark.
The South China Morning Post has summarized some of the supply chain issues, from limited worker mobility due to quarantines to cargo ships being blocked from docking in ports in Europe, Australia, and Asia. China is expected to experience historically low productivity this year. But, this doesn’t only hurt China. Apple already announced that it will have negative quarterly reporting as a result of the Coronavirus quarantines in China. According to a New York Times article, Amazon is worried it will be hit hard by a shortage on Prime Day. The article included samples of emails Amazon has sent to vendors and companies who sell via Amazon.com either ordering up to six times the normal orders or encouraging suppliers to make sure they’ll be able to stock goods. It’s the retail equivalent of a snow day run on bread and milk at the grocery store. The article also mentioned that some other brick and mortar retailers could run out of everyday goods like ink cartridges and sponges as early as April because they simply won’t be available. Most imported goods in the United States come from China.
Speaking of snow day runs on bread and milk at the grocery store, Covid-19 has caused some panic-buying/hoarding as well. Videos have been circulating the internet of empty shelves at stores in Hong Kong and Northern Italy, and in Hong Kong, there was even a toilet paper heist. If the supply chain is disturbed and Coronavirus does become a global pandemic, you can bet I’ll be hoarding toilet paper too.
Besides supply chain issues, there are also major travel industry issues. Multiple cruise ships have been quarantined or rejected from ports, some cruises have been canceled, flights are at a standstill across China with only charter flights occupying the air space. And, Chinese people are major travelers. Whole portions of the global economy can be effected without Chinese tourists using hotels, flying on commercial airlines, and buying goods. A study published by Nielsen says that in 2016 Chinese tourists spent more than tourists of any other nationality: $261.1 Billion US Dollars. That number was expected to continue to rise at the time the study was published. The travel industry led the stock declines today.
Closer to home, the Houston Chronicle posted an article featuring 33 places to eat in Chinatown after false rumors of a local Coronavirus case caused business to all but dry up for many Asian-owned establishments.
