In the face of Covid-19, markets have experienced volatility not seen since the dreaded 1930s. Stocks were at all-time highs as recently as mid-February, then plunged anywhere from 25 to 40% or more in response to the pandemic.
Investors must make key decisions. Over 1/3 of the country is subject to stay at home rules. Thousands of new infections are reported daily while fatalities soar. Hard hit NYC is reporting a new death every 13 minutes.
In a nutshell, should investors sell and move to the sidelines, to await some signs of stabilization? Should they simply stay the course? Or should they proactively increase market exposure to get back in line with their planned asset allocation targets?
Investors should first reexamine their risk tolerance and time horizons. Assuming nothing has changed, the pandemic provides the best opportunity in decades to take advantage of low prices and add equities to your portfolio. Rebalance to your equity target.
Although the recent volatility rivals that seen in 2008-2009, 1987, 1973-74, and the 1930s, there’s no indication that ultimately the market won’t rebound to new highs. Timing is never certain. Health panics can’t be cured by economic and financial tools. However, this country has seen severe health crises before and has never failed to surmount them.
The utter resolve of our policymakers to mitigate the financial effects of the virus is unprecedented. Although the long-term effects of the stimulus can be debated, near-term stimulus exceeding 10% of GDP will be extremely helpful.
Why Asset Allocation Matters
Amid the volatility, remember why serious investors employ an intelligently designed asset allocation. Although allocation models can be complex, consider a simple, traditional 60/40 division between stocks and bonds.
The allocation does two things. First, it allows you to stay prepared for the unexpected. It acknowledges that the future is never certain, providing a way to reflect the better than even odds that stocks outperform over the long run but hedging the possibility it isn’t always the case. After all, if you knew exactly what the short term would bring, you wouldn’t need an asset allocation. If you knew stocks were going to outperform, you’d have 100% of your portfolio in stocks. If they were going to underperform, you’d have 100% in cash.
The other virtue of asset allocation is when market volatility causes stocks to dip, you have some “dry powder” to take advantage of the lower prices.
Whenever your stock/bond balance deviates from your plan, for example you are 50/50 stocks/bonds versus the planned 60/40, that’s a signal to subtract from the over weighted asset class, in this case bonds, and add to the underweighted one. Rebalancing is acting on that signal in the exact amount required to restore your portfolio to the planned asset allocation.
Rebalancing forces you to subtract from the outperforming asset class and redeploy into the underperformer. Most investors can understand the logic behind this; emotionally this is challenging to do. Our human nature is to embrace what has been performing better, to stick with what’s working, and to extrapolate further gains. We want to shun what’s recently disappointed.
However, rebalancing reduces risk by reducing exposure to the outperforming, and thus relatively expensive, asset class. It has the potential to increase performance by forcing you to buy what is relatively inexpensive.
How often should you rebalance? Many advise rebalancing should only be done after a set period or when there’s a minimum amount of misallocation. We believe rebalancing should occur whenever market movement has created a not insignificant misallocation, subject to considering any transaction costs or adverse tax implications.
The Case Against Rebalancing Now
The best reason not to rebalance now is if there’s been a change in your personal circumstances that makes your legacy asset allocation no longer appropriate. A health set back, a job loss, some sort of financial reversal may call into question the appropriate commitment to risk assets. A change in your investment horizon, say a desire to buy a second home, also may call that into question.
We are skeptical of those who, despite no change in their circumstances, would now ignore the rebalancing opportunity. Typically, the objection is that under the current pandemic circumstances the market will go lower. Why not wait until the market is lower before rebalancing into stocks?
To now claim during the pandemic-caused volatility to have enhanced predictive power is inconsistent with needing an asset allocation. An asset allocation implies the future course of events is impossible to divine with certainty. Rebalancing relies on what is a fact, that equities have come down in value relative to fixed income and are therefore cheaper, and couples it with the same agnosticism as to whether the market will shoot up or descend lower.
Our advice is to take advantage of the lower prices without trying to make an impossible forecast of what the market will do short term.
Reasons for Long Term Optimism
The case for long term equity outperformance is compelling, especially given the current circumstances. First, there’s never been a health crisis this country did not get through. Our country has been through many, including the Spanish flu, polio, and yellow fever. Given superior communications and biotech tools, the likelihood of developing responsive cures, vaccines, and testing kits in a relatively short time is quite high.
There has never been a stock market dip, correction, bear market, or crash without the market ultimately rebounding to new highs. While years have sometimes been required, those investing for retirement are highly likely to have a time horizon that’s much longer than the probable duration of the downturn. Fixed income can frequently handle needed withdrawals in the interim.
The Resolve of Our Policymakers
This country has never seen monetary or fiscal policy of such magnitude and arranged so quickly.
On the monetary front, we have never before seen the Federal Reserve execute two intra-meeting rate cuts. Rates have been lowered in short order to match the lowest Federal Funds rate previously notched, in the 2008-9 downturn. The Federal Reserve has noted there are no limits to its new quantitative easing programs. For the first time ever, the Fed has started supporting the corporate bond market by investing in investment grade corporate bonds via purchase of the exchange traded fund iShares IBoxx $ Invest Grade Corp Bd Fund (LQD). We believe, if conditions warrant, that the Federal Reserve will prop up high yield bonds by purchasing ETFs holding them.
On the fiscal front, the firepower has been nothing short of awesome. The just enacted CARE legislation carries a price tag of over $2 trillion, representing more than 10% of GDP. The speed in which it was put together, in less than two weeks, compares favorably to the time that it took to put together any similar legislation. The value is over three times the relief package assembled during the 2008-2009 bear market. The nearly unanimous support for the legislation also suggests that if more stimulus is yet needed, it’s highly likely to be forthcoming.
The legislation aids targeted industries, including airlines, restaurants, retailers and community banks, and companies deemed too important to fail, like Boeing. The bill seeks to reduce the pain on small business by providing billions for loans. Unemployment benefits are broadened and enhanced. Most Americans, subject to income caps, will receive a $1,200 check to help on expenses.
In investing, as in life, nothing is risk free or guaranteed. The most important risk is the virus itself. Dr. Fauci, director of the National Institute of Allergy and Infectious Disease, has rightly noted that the government does not set the timeline, the virus does. Rebalancing will not assure a profit if markets keep declining.
Because this is a natural disaster, the dimensions of which are unclear, investors shouldn’t try to time the market or predict a bottom. Bottoms are not predicted in real time. They only become evident well after the fact.
The news flow will get worse as cases rise and deaths mount. The response of the people and governments is not subject to precise prediction. Joblessness may reach record levels; pundits expect a double-digit drop in GDP. However, historically markets bottom prior to the nadir. Stocks look forward, up to two years ahead. Expect investors now to look past results expected for the next several quarters.
Staying on the sidelines has risks as well. Interest rates have moved to nearly 0% on money markets, while short dated Treasuries now carry negative rates. Yet, few expect inflation longer term to be a no show. Policymakers’ open check book approach has inflationary implications longer term, especially if the downturn is less deep or long than feared.
In sum, if your investment objectives remain unchanged, take advantage of the low stock prices by rebalancing your portfolio to your planned asset allocation.
Note: David Dietze is President and Chief Investment Strategist at Point View Wealth Management.
Point View Wealth Management is an SEC-registered investment adviser and part of Peapack Private Wealth Management. For over 25 years, Point View Wealth Management has been providing customized portfolio management services and comprehensive financial planning solutions for individuals and their families to develop and achieve their financial goals.
Contact us at email@example.com or call us at 908-598-1717 to learn more about us and how we can help you and your family meet your financial objectives.
Point View Wealth Management is located at 382 Springfield Avenue, Suite 208, in Summit.
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