- “History provides a crucial insight regarding market crises: they are inevitable, painful and ultimately surmountable.”- Shelby M.C. Davis
- “The investor’s chief problem – and his worst enemy – is likely to be himself. In the end, how your investments behave is much less important than how you behave.”– Benjamin Graham
- “Knowing what you don’t know is more useful than being brilliant.”- Charlie Munger
- “Be fearful when others are greedy, and be greedy when others are fearful.”
- Warren Buffett - “It’s not the mountain we conquer, but ourselves.”
- Sir Edmund Hillary - “To get what you want, you have to deserve what you want. The world is not yet a crazy enough place to reward a whole bunch of undeserving people.”
- Charlie Munger
Key Points
- The rapid decline in stock values in March 2020 is called a waterfall decline. In 18 days, the decline was the fastest on record from a record high to a bear market. The left portion of the chart below illustrates just how fast and steep this decline was compared to waterfall declines in 1929 and 1987.
- In the 18 times the S&P 500 has dropped 15% or more in one quarter, it has climbed the next quarter 67% of the time by a median of 5.8%. One year later, the median gain is 17.3%.
- An historic assessment of waterfall declines and bear markets in general reveals a prevalent four-step bottoming process: 1) Oversold selling climax; 2) Rally (bounce(s)); 3) Retest (70% of the time with lower lows) but with less total volume, less downside volume, fewer stocks making new lows and fewer stocks below their moving averages) and 4) Breadth Thrusts (broad increases across stock types/classes).
- Note that the market can bounce from step 2 to 3 several times, but if several breadth thrust indicators fire bullish signals, we will seriously consider a partial or full rebalance move (increase equities back towards or to full target weight from present underweight levels).
- It is certainly possible that the sell climax low was already hit on March 23 (S&P 500 = 2213). In reviewing numerous valuation analysis and assessments by other respected analysts, when the S&P 500 bounced back up to 2600, we assessed what possible downside retests may look like. Whether it is a -5% retest (to 2470), a -10% retest (to 2340) or a dire -17% retest (to 2158 or lower), it is too speculative for long-term investors, in our expert opinion, to attempt short term market timing moves and potentially miss out on robust rebound days (see right side of chart below). Rather, the long-term investors focus should be to 1) weather the storm, 2) adapt/tweak where needed, 3) rebalance when/if bottoming signals (and virus containment possibilities) flash a buy and 4) don’t miss out on significant deep-discount opportunities and a robust rebound when it occurs (which can be at any time).
- Out of caution for the unknowns and the high possibility of a variety of negative news (arguably already priced in, but not for panic sellers) on several fronts, we have elected to wait to rebalance until our bottom watch indicators flash buys and, hopefully, more news about virus containment, cures and economic revival hits the news cycles. If we miss out on rebalancing due to too small/ short a window, we still participate in the recovery at a fine level. Given risk/reward dynamics and the typical profile of our clients, we believe this is the best approach at this time. Let us know if you would like to discuss or implement a different approach.
Executive Summary
The global economy started the year stronger than we have seen in decades. Fresh off upbeat fourth quarter earnings, improved business sentiment and a freshly completed U.S./China (phase 1) trade deal. However, valuations and optimism in stocks were pretty high, causing us to maintain a disciplined stock/ bond mix (neutral weighting) and to de-risk underlying holdings for more downside protection in the event of a correction.
What a difference a few months can make. The first quarter of 2020 will go down in history with a formidable black swan event (the COVID-19 pandemic) – and the stock market suffered its worst first quarter on record as social-distancing actions, to help mitigate the spread of the pandemic, wreaked havoc with unprecedented economic uncertainty, fear, layoffs (potentially short term) and disruption.
Our message to clients, based upon years of proactive actions regarding the merits of “Investing from a Position of Strength,” is clear: 1) Weather the storm, 2) Prudently adapt where needed and 3) Don’t miss out on the significant deep-discount opportunities and robust rebound when it occurs.
As always, our aim, with this report, is to give you a very brief but accurate lay of the land so that we can collaborate with you to successfully navigate this harsh storm and be in a good solid place with you when it subsides.
Economic Key Points
- As noted on the economic indicators below, all aspects of the economy were on solid ground coming into the COVID-19 pandemic crisis.
- The very actions to “flatten the curve” of the pandemic (a good thing) have broad and deep economic implications (a challenge) and this will severely impact the world economy during the second quarter and at least partially impact the economy into the third quarter of 2020.
- Investors are seeking to assess if a “V” recovery (rapid), “U” recovery (gradually building), “W” recovery (double dip/recovery) or “L” recovery (slow/ugly) is in our future. Nobody knows for certain, but governments, medical/pharma/biotech/health institutions, and businesses are doing their best to contain the crisis and orchestrate a robust recovery.
- Fiscal stimulus (upwards of $6 Trillion in the U.S.) has quickly been implemented into law and policy has been well received by investors. Further stimulus plans are also being considered, clearly telegraphing a “whatever it takes” response to this crisis.
- As this COVID-19 pandemic is ultimately controlled and innovations in testing, mitigating (antivirals) and/or preventing (vaccines) the virus ultimately come to market, the economy and financial markets will bounce back.
- We expect casualties (particularly in the most impacted industries) but also anticipate a gradual but ever-increasing move back to most “business as usual” economic activities.
Equity Top Takeaways
- Large-Cap U.S. stocks fared much better than Mid-Caps, Small-Caps and International Developed Stocks. Fortunately, when we de-risked portfolios in 2019, we over-weighted U.S. Large Cap stocks (and underweighted Global stocks), including overweighting the Consumer Staples sector, which was one of the best performing sectors.
- As the crisis unfolded, we quickly acted to reduce our Small Cap exposure, in portfolios where we held them, shifting holdings to Low Volatility Mid Cap and Large Cap Momentum strategies for more defensive purposes.
- Most of our portfolios are presently ~ 5% to ~ 10% underweight equities for defensive purposes and we plan to remain so until our bottom watch indicators flash a buy signal.
- Emerging Market stocks, ironically, held up relatively well during the crisis.
- Frankly, there were no places to hide in the equity markets. All 11 GICS sectors finished the quarter with double digit losses. The energy sector suffered its worst quarter since 1972, falling over 50%.
- We believe the market has already priced in significant economic damage. Accordingly, rebalancing portfolios at or near favorable panic prices is advisable for long term investors, particularly when/if signs of a four-step bottoming process are flashing a buy signal.
Fixed Income Top Takeaways
- Fortunately, our portfolios are constructed with a number of high-quality investment grade fixed income instruments which have greatly reduced overall portfolio volatility during this crisis. The level of this volatility control is proportionate with each client’s individually selected stock/bond mix.
- The flight to quality boosted treasuries (long term Treasury Notes appreciated as much as 20%).
- Early in the crisis, supply and demand inconsistencies caused dealers to slightly discount investment grade corporate bond and municipal bond prices. However, the Fed and Treasury quickly stepped in to guarantee liquidity and the bond markets rapidly recovered from this temporary anomaly.
- High Yield bonds depreciated in value due to the threat of increased default. As another precautionary step, we sold out of our small position in High Yield bonds and placed sale proceeds in cash for defensive purposes and to be ready for a potential rebalance move.
- The Fed has provided a backstop for investment grade issuers, increasing the incentive to keep investment grade status. We continue to favor financially strong investment grade issuers.
To see our full Investment Commentary Report, including illustrations, click here.
Important Disclosures
The content herein is to be used for informational purposes only. Neither Janiczek Wealth Management or its owners and employees represent or warrant the accuracy or completeness of the information contained in this report. In no event will Janiczek Wealth Management or its owners or employees be liable for any damages that may result from the use of or reliance on these materials.
Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments and/ or investment strategies recommended and/or undertaken by Janiczek® Wealth Management (“Janiczek®”), or any non-investment related services, will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Janiczek® is neither a law firm nor accounting firm, and no portion of its services should be construed as legal or accounting advice. Moreover, you should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Janiczek®. Please remember that it remains your responsibility to advise Janiczek®, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/ revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. A copy of our current written disclosure Brochure discussing our advisory services and fees is available upon request. The scope of the services to be provided depends upon the needs of the client and the terms of the engagement.
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Rally Watch Indicators
Clearly Step 1 (Oversold Selling Climax) of a 4-Step bottoming process has decisively occurred on March 23, 2020.
Step 2 of the bottoming Process (Rally (bounce(s)) has/is also occurring with overall indexes well off lows. The immediate “bounce” up from the March 23 panic sell low has been impressive.
Step 3 of the bottoming process (Retest(s)) is what we are expecting. This does not mean back down to March 23 lows or lower, but 70% of the time historically new lows are reached. We’ve had some modest down days, but not to the extent of an authentic retest. As in late 2018 to early 2019, a retest does not always occur, but we remain suspicious.
It is very possible to bounce between Step 2 and 3 back and forth. We will see.
Step 4 (Breadth Thrusts) is really what we are looking for to take advantage of fat pitch opportunities. The Rally Watch tool we use has 16 indicators and we look for 8 or more flashing green. Presently, we’ve had 2 to 7 flash green, indicating the bounce is not as widespread as we’d like. Thus, this indicator (one of many considered) suggests we remain in Step 2 and 3 range.
Please note, in no way do we want to suggest we are using this indicator to make extreme asset allocation changes. Our typical portfolio is presently ~10% to ~5% underweight equities, from a neutral position (slightly defensive). The above discussion has more to do with the timing for a relatively modest rebalance move (back to neutral weight equities) and, in certain cases, for when allocations of excess cash ready to invest will be deployed.
Bear Watch Indicators
Presently, 40% of our bear watch indicators are red and 20% are yellow (near red). We would find it bullish when 20% or less of these indicators are red. Until then, more wide-moat, low vol and dividend paying type equities are emphasized in our portfolios.
Note that we look at opportunities across the investment spectrum. For instance, spreads in certain bond categories look promising and certain areas/sectors of equities look more promising than others. Accordingly, indicators like this Bear Watch Indicator simply partially inform investment risk on and risk off decisions.
Global Recession Watch Indicators
Our Global Recession Watch report consists of seven key indicators. When 5 of 7 of these indicators reach their key recession levels, a recession call may be made. Presently, 6 of 7 are triggered.
The depth and length of a recession is really what investors eyes are on at present. Since investment markets look to the future and respond much faster than economic indicators, we would expect the markets to respond much sooner than economic and employment statistics. Even so, monitoring economic indicators forward provides important inputs to certain decisions.
More Resources:
When a major event, like the COVID-19 pandemic, disrupts the economy in multiple ways, it is very natural for the investment markets to respond in a volatile way. There are four key inputs that should guide your portfolio management upgrading decisions at this time:
- How was your investment portfolio positioned prior to the COVID-19 disruptions? Were you heavily on the offensive? Were you defensive? Were you neutral? Was your stock/bond mix aligned with your long-term target? Was your portfolio management set up to properly respond and adapt to changes in the SWOT (strengths, weaknesses, opportunities and threats) of the market as conditions rapidly changed or is your portfolio management not set up for active defensive, offensive or neutral management?
- How did you (or your portfolio managers) respond to the changing circumstances and waterfall decline (panic selling period thus far peaking March 23, 2020)? Were any defensive moves executed before, during or after? Were any offensive moves executed? Have you (or your portfolio managers) rebalanced your portfolio to your targeted stock/bond mix yet or are you (or your portfolio managers) strategically waiting for more inputs on continuing pandemic and economic developments?
- Looking forward, are you in the position and are you desirous to take advantage of opportunities from distressed panic selling or would you like to be a bit more cautious and defensive during this time?
- Upon reviewing other parts of this website on the topic of Investing from a Position of Strength®, on a scale of 1 to 10 (1 being very poor, 10 being exceptional), how strong a position do you believe you are in to weather this economic storm?
Regardless of whether you discuss your answers to the above four questions with us or your current advisor(s), we think your answers will set the tone well for your next actions.
