May 29, 2020
In several previous emails, we have highlighted the significance of several basic investment principles: resisting the urge to time the market, not allowing fear to drive decision-making, and the idea that markets will begin to recover before the worst of the economic news has been released. The last several months have been perhaps the clearest ‘object lesson’ of these principles of my 30-year career. At the risk of beating the drum too hard, I offer the following observations of the markets over the last few months, and a few thoughts about what should be considered for investment success in the future.
From late February to March 23, we witnessed one of the sharpest and most sudden stock market sell-offs in history. During that period, the S&P 500 lost over 29% in only 18 trading sessions, a historic sell-off indeed. Throughout late March, uncertainty and fear prevailed, with forecasts for the economy and the path of the virus that were ominous. The Fed was slashing lending rates and easing monetary policies, and a historic fiscal package was making its way through Congress. The impulse to hunker down and ride the situation out was the order of the day. There were few, if any, bright spots. So, if late in March you were told that the next two months would bring a stock market rally that would rival any in history, you probably would not have believed it. Few, if any, investors I know would have been comfortable diving in headfirst to stock back then.
IN INVESTING, WHAT IS COMFORTABLE IS RARELY PROFITABLE – Robert Arnott, Investor and writer
Hindsight is 20-20…
Tuesday the 19th, marked the 40th trading day since the low for the S&P 500 that occurred on March 23… the S&P was up over 32% in that time.[1] Interestingly, the history of +6 and +12 month returns following these relief rallies have also been strong, typically coming in well above the longer term averages. We may see a more protracted market recovery, as the coronavirus situation remains fluid. Until a vaccine is discovered and distributed, the market is actually discounting an impending return to more normal conditions. Moreover, the S&P up more than 2.0% since a year ago, unlike now we were flaunting a remarkably low unemployment rate, strong housing, and an economy that seemed to be expanding on all fronts. This current rally seems counter-intuitive; as the economic data does not reflect much of an improving situation at this point.
To be sure, what the market is worried about is the economic reality. We are in a recession… and this is no ordinary recession. The U.S. economy will shrink this quarter by a substantial margin. The Congressional Budget Office projects a 38% drop,[2] which is about in line with the projections of many economists. In addition, the CBO projects a budget shortfall of about $2.2 trillion in fiscal 2020. In April, the Bureau of Labor Force Statistics put the unemployment rate at 14.75%,[3] and it is expected to reach nearly 16% during the third quarter. Questions we have to ask… is the market detached from the economic reality? And what business does the stock market have in rallying, anyway?
SKATE TO WHERE THE PUCK IS GOING TO BE, NOT WHERE IT HAS BEEN – Wayne Gretzky, hockey great
This has become an over-used, tired quote, often employed by CEOs, consultants and the like… to express the power of aiming at (and investing in) upcoming developments rather than focusing on what may have just happened. Nonetheless, it illustrates what astute investors attempt to do on a daily basis.
The situation in which we find ourselves now is difficult… to say the least. We believe that it will take years for the economy, and perhaps the broad market indices themselves, to recover to previous levels. Beyond that, we think it may become apparent that the economy will not ever recover to previous levels, but rather become an economy that looks markedly different than the one of 2019. But, in this market, we think insightful investors will find that it will not be the magnitude or pace of the recovery, that will be central to investment success, but rather simply the direction. The extent to which a recovery can sustain itself will be the key issue. Within the reshaping of the economy… some industries will see a faster rebound, others will lag. Some may go through continued disruption.
ONCE YOU REALIZE YOU DESERVE A BRIGHT FUTURE, LETTING GO OF YOUR DARK PAST IS THE BEST CHOICE YOU WILL EVER MAKE. – Roy T. Bennett, author
Since about 2010, it seems that everything has been going up; stocks, bonds… asset class correlations were high, and it made being invested more straightforward. Volatility was low, and a diversified portfolio did just fine as long as investors stayed the course through the few disruptions that occurred. With periodic rebalancing, investors saw decent returns on most fronts, and even indexing became a trend.
Given the economic calamity that has been Covid-19, in the future, simply owning a broadly diversified portfolio will be less effective in managing risk and generating desired returns. Avoiding strategically indeterminate investments, or challenged sectors, industries and investment styles may become much more important to continued success.
Unlike the last decade of high asset class correlations, we think that secular shifts may be developing in several areas of the economy, and will necessitate active portfolio adjustments in order to successfully navigate. For example: consumers who support the vast majority of economic activity in this country may change their spending and saving practices. Which, in turn, affects related industries and sectors. Asset flows to certain investment styles will likely shift as well. Being in the right investments will mean more than being diversified across the board. It may become more of a winners and losers game going forward.
In addition, we think that a return to heightened volatility is here, and managing it will be another key to investment success. Accordingly, we at Atlas, will continue to monitor manager performance vs. their appropriate benchmark, and in doing so pay particular attention to the unique factors associated with active risk management. In an environment of heightened volatility, managing downside risk can be as important as capturing upside moves.
We think that liquidity has regained its justified premium through this crisis, and will continue to command that premium for the foreseeable future. That is why we at Atlas have avoided certain investment structures as a standard practice. The attraction of higher potential returns in exchange for limited liquidity has been compelling to many investors, but in times of volatility, those investments can be both difficult to valuate and to hold. Managing these risks has always, and continues to be a focus of our Portfolio Management Group.
So, we are now three months in to this pandemic-driven market, and the lessons of the past have held true. While we do believe that, the approach to investing in the future will demand that portfolio managers give greater attention to the secular changes taking place in the economy, sector and industry allocations, and liquidity, we continue to recognize that consistency of approach and insightful active management remain the cornerstones of a successful strategy.
Of course, if you have any questions or concerns, please feel free to contact your Atlas Wealth Management Advisor. They will be happy to discuss your specific situation with you.
John C. Ogle
Chief Investment Officer
[1] As of 5/20/2020
[2] Congressional Budget Office Interim Projections for 2020 and 2021 https://www.cbo.gov/publication/56351
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