Stock market rout not the time for wholesale portfolio changes
The rapid spread of the Covid-19 virus (also known as the coronavirus), has hit global markets hard over the past few weeks as investors worry about the impact of the spreading contagion on global trade and corporate earnings. Stock market indexes have plunged well into correction territory (down more than 10% from recent highs), crude oil has dropped to levels last seen in 2017, global growth appears to be slowing, and with a possible recession looming, central banks are cutting interest rate cuts.
This really doesn’t come as a surprise to professional wealth managers. Your portfolio managers are always monitoring markets and broader macro-economic trends, with the objective of taking action within the pre-set mandates and risk parameters of portfolios.
The long-running bull market in stocks had produced strong returns on investments for a long time, but was already getting very toppy and needed a correction badly as valuations were being stretched beyond what many consider reasonable. The yield-curve inversion a few months ago also signaled trouble ahead. All it needed was a trigger.
And the impact of the spreading Covid-19 virus provided that trigger, as markets downgraded earnings expectations, forcing p/e ratios back down to earth. As with previous flu-like infection scares and “pandemics,” the effects are very probably overdone and are likely to impact markets for a couple of quarters before normal trade and business pick up again to full capacity. Many analysts are already predicting a strong recovery in the second half of the year.
We’ve seen in the past that such periods of volatility are never a good time for wholesale portfolio resets (especially if you’ve built portfolios according to your true risk-tolerance levels). That means avoiding portfolio decisions based on the daily diet of rumor, hyperbole, and misinformation dished out by the daily media feed. It also means sticking with your financial plan. It’s designed to work precisely through these types of events, mitigating risk where mandated and positioned to recover into the next market upswing.
Here are some tips on how to avoid being whipsawed by the market:
* Don’t sell on emotion. The market is an emotional place. There’s fear. There’s greed. There’s high drama. You can grow too attached to an investment. Or come to loathe it for no good reason. Or you can be a lemming, and just do what everyone else does, happily running over a cliff.
If you get the urge to sell an asset, ask yourself why. What is it about the asset that’s changed? Have a stock’s fundamentals deteriorated badly – revenue, cash flow, earnings? Has the company declared bankruptcy? What’s changed since yesterday, when you thought your investment was brilliant? Has the stock reached your pre-determined sell target level? If you have no good reason other than “the market is falling,” you’d better re-check your risk tolerance and your ability to withstand market volatility. Maybe move into a savings account or purchase some guaranteed investment certificates – where the only guarantee is that you’ll lose money for sure, with no comebacks.
* Avoid market timing. Many investors have an unfounded confidence in their ability to buy and sell an investment at precisely the right time to maximize profit and portfolio performance. In practice, this is almost impossible to achieve consistently.
Attempting to “time the market” leads to frequent trading, incurring trading costs on both the buy and sell side. In addition, because no one has a crystal ball, chances are good you’ll miss both the top and the bottom of a trend or a cycle. And chances are good you’ll be whipsawed. Overall, you’ll have incurred trading commissions, and you’ll typically be no further ahead than if you had stuck with a disciplined price-target strategy.
* Don’t obsess about the business news. Novice investors fret way too much about the markets. Those without the benefit of a financial plan and professional portfolio management are especially prone to market fretfulness, particularly as the 24/7 news cycle never shuts down! Many investors succumb to the daily panic-inducing headlines and tweets from the business news media. I’ve found that tuning out the daily business news “noise” goes a long way to restoring peace of mind. Remember, all that breathless reporting and those “crisis” headlines change by the minute – and there’s never a time of no crisis. It’s all designed to get as many “eyeballs” as possible to news websites and thus deliver a massive “visitor metric” to advertisers on those very same websites and social channels. Check the news if you must, but take it with a huge grain of salt.
* Don’t follow the herd. Investors often stampede into or out of individual investments, sectors, asset classes, and entire markets at the same time. New clients have told me they’ve missed out on big market moves after selling all their equity positions and switching to cash after a stock market correction. Many novice investors jumped on the sell bandwagon in late February simply because “the market was declining rapidly.” In fact, “the market” is nothing more than the combined actions of millions of individual investors. If you sell only because the market is declining, you’re just following a herd mentality.
* Have a plan…and stick to it. The best way to keep that urge to emotional trading in check is to have an investment plan in place. Decide what your goals are, what your risk-tolerance level is, and allocate your assets according to a realistic assessment of your investment temperament – before you jump into the market. As the writer George Goodman (“Adam Smith”) once put it, “If you don’t know who you are, this is an expensive place to find out.” Many (perhaps most) investors overestimate their ability to tolerate risk and market volatility.
Your investment plan will take into account the market’s many moods and its volatility. Your portfolio will be built to be more “defensive” or more “aggressive” to suit your needs, with built-in risk-mitigation derived from proper asset diversification. That means you shouldn’t have to worry about the market’s ups and downs – your portfolio should perform comfortably within the parameters you’ve set, with no need for you to go and meddle and “try to make it better.” If you’re in an actively managed portfolio mandate with a professional investment manager, they’ll typically have flexibility to switch from a more aggressive stance to a defensive one within the mandate, and likely will already have done so at the first sign of market fragility. Your portfolio will in all likelihood suffer short-term losses, but – and this is the key – not to the degree that the broader market indexes do.
* Get the right advice. This might seem self-evident, but even my new high net worth clients who seek my counsel complain that they just weren’t getting the right kind of financial advice. And that’s absolutely true if you base investment decisions on the latest business news headlines and the 24/7 news feed. That’s just a variant of trading on emotion and committing the sin of market timing. It’s something to avoid at any cost. Almost as bad is the type of “advice” that comes from relatives, neighbors, colleagues, or unsolicited advice that “the bear market is starting” or that “a recession is a sure thing,” or any other baseless piece of market rumor.